Buying vertical spreads

[PohPoh]

I've been noticing how BAD it is to buy time when trading bull call or bear put spreads. It's the worst thing you can do to tie up capital for so much time. I'm starting to get a better handle on ratio spreading and even just 1-1 spreads but now buying with under 30 days to EXP, right at the money.

Does anyone have any advice or reco's on trading put/call spreads???

 

[MTE]

Quote from PohPoh:

I've been noticing how BAD it is to buy time when trading bull call or bear put spreads. It's the worst thing you can do to tie up capital for so much time. I'm starting to get a better handle on ratio spreading and even just 1-1 spreads but now buying with under 30 days to EXP, right at the money.

Does anyone have any advice or reco's on trading put/call spreads???

It's always a trade off. By buying more time you have greater chance of the stock hitting your target, but at the same time you greatly reduce your potential profit if the stock makes a quick move towards your target and you are left with lots of time value in the options.

 

[PohPoh]

I wouldn't say that you have a greater chance of hitting your target, you just have more time to..right?
Anyways, I bought a huge ammount of time in at the money spreads and the market just ran away from me....so I'm now buying very little time expecting shorter moves..

 

[kny3]

Spreads are price sensitive. The underlying needs to get to a certain level (or not to a certain level if you're doing a credit spread).
Spreads are time sensitive. Spreads won't go to their maximum value until expiration.

So that's the conundrum (I like that word). If you want an extra month or 2 to give yourself more time it's not usually that much more expensive. But if the move that you expected happens in a short time, you do well, but a shorter month would have done much better, price wise & return wise.

Example(not a good one, but you get what you pay for):
stock at $50. You buy 3 month 50/60 call vertical spread. Stock goes to $60 with 45 days left. Your spread doing well but 60 day spread was cheaper and is trading for more than yours. Which option holds the most time premium? The at-the-money, the 60 call you are short.

Hope this explains a little.

kny 3

 

[cohenmichaela]

kny3 is correct. The more time there is the flatter the gamma curvature. If you're using verticals to strictly accumulate deltas I'd stick with the front month and work on hedging your theta.

I've been experimenting with using no-touch barrier hedges on long strangles. I then convert to verticals when the long strike is ATM.

Quote from kny3:

Spreads are price sensitive. The underlying needs to get to a certain level (or not to a certain level if you're doing a credit spread).
Spreads are time sensitive. Spreads won't go to their maximum value until expiration.

So that's the conundrum (I like that word). If you want an extra month or 2 to give yourself more time it's not usually that much more expensive. But if the move that you expected happens in a short time, you do well, but a shorter month would have done much better, price wise & return wise.

Example(not a good one, but you get what you pay for):
stock at $50. You buy 3 month 50/60 call vertical spread. Stock goes to $60 with 45 days left. Your spread doing well but 60 day spread was cheaper and is trading for more than yours. Which option holds the most time premium? The at-the-money, the 60 call you are short.

Hope this explains a little.

kny 3

 

[momoneythansens]

Quote from cohenmichaela:

I've been experimenting with using no-touch barrier hedges on long strangles. I then convert to verticals when the long strike is ATM.

Converting to a vertical will leave you massively short gamma going into the barrier

My interpretation is that you are using the no-touch to "tempt" the underlying so that you make money on your strangle and also offset some/all of the debit of the strangle. Sounds like a hybrid short fly. You then attempt to lock-in profits on the strangle by converting the appropriate side to a vertical - a gamma scalp if you will. Have I understood correctly? If so, the strike selection for the barrier has to be such that the payoff is large enough to be meaningful with respect to the debit of the strangle and also the payoff of the converted vertical has to be sufficient with respect to possibly covering the debit of the barrier.

Interesting but not convinced

MoMoney.

 

[cohenmichaela]

Quote from momoneythansens:

Converting to a vertical will leave you massively short gamma going into the barrier

My interpretation is that you are using the no-touch to "tempt" the underlying so that you make money on your strangle and also offset some/all of the debit of the strangle. Sounds like a hybrid short fly. You then attempt to lock-in profits on the strangle by converting the appropriate side to a vertical - a gamma scalp if you will. Have I understood correctly? If so, the strike selection for the barrier has to be such that the payoff is large enough to be meaningful with respect to the debit of the strangle and also the payoff of the converted vertical has to be sufficient with respect to possibly covering the debit of the barrier.

Interesting but not convinced

MoMoney.

You have it right. I've been buying SPX strangles (25 pts OTM). My idea behind the no-touch was to partially offset any theta loss due to lack of realised volatility. I've been getting quotes of around 200USD for a 2000USD payout on 3 week no-touch barriers (at my strangle strikes).

When converting to the vertical I do so to hold the spread at 0 cost (or small credit). Based on my modeling, I believe the deltas I'd accumulate on the long strike would more than offset the cost of the strangle and of the no-touch based on the barrier quote above.

Here is where I'm uncertain on how I'd like to play it. I could liquidate the losing long position to make it directional. I was also thinking of using an expiry or not-touch at this point at the newly created short strike. I'm not sure what the payout would be or the expiration of the contract so I guess I'll just wait and see. Obviously it would make sense if I could construct the exotic to lock in a profit regardless of price movement.

I'm not convinced either but it might be fun...

 

[cohenmichaela]

Quote from cohenmichaela:

You have it right. I've been buying SPX strangles (25 pts OTM). My idea behind the no-touch was to partially offset any theta loss due to lack of realised volatility. I've been getting quotes of around 200USD for a 2000USD payout on 3 week no-touch barriers (at my strangle strikes).

When converting to the vertical I do so to hold the spread at 0 cost (or small credit). Based on my modeling, I believe the deltas I'd accumulate on the long strike would more than offset the cost of the strangle and of the no-touch based on the barrier quote above.

Here is where I'm uncertain on how I'd like to play it. I could liquidate the losing long position to make it directional. I was also thinking of using an expiry or not-touch at this point at the newly created short strike. I'm not sure what the payout would be or the expiration of the contract so I guess I'll just wait and see. Obviously it would make sense if I could construct the exotic to lock in a profit regardless of price movement.

I'm not convinced either but it might be fun...

Sorry, misquoted the barrier. Around 350 - 400 for the no touch at the short strikes.

 

[xtrhvydty]

To the poster: Get Natenberg's Option Volatility and Pricing, see page 452, 454 showing grids of how to pick the right strategies. Essentially, you can make a living using Time Spreads, Butterflies, Bull/Bear Butterflies, and Put/Call Backspreads IF you carefully quantify your risks using the greeks. The following is a list of the major risks in option trading. It's obvious why one would fail without quantitative evaluation of each:

1. Direction risk (position delta)
a. up
b. down
2. Movement (position gamma)
a. large move (2 standard deviations)
b. small move (1 standard deviation)
c. no move
3. IV (position Vega)
a. increase
b. decrease
c. unchanged
4. Time passage (position theta)
a. helps
b. hurts a little
c. hurts a lot
5. Liquidity or slippage risk: An OTM or ITM call, as well as unhedged spreads during fast markets will lose more as you try to close out the position.

That’s 12 major risks