calculating risk reward

[Jebediah]

Hi all

A number of related questions:

1. Anybody recommend an options/futures broker offering demo account ?
2. How can you calculate the risk to reward of an option and know the profit potential before entering?
3. would it be possible to develop a strategy consisting of buying cheap option positions for every scenario (bullish, bearish and neutral) all with the same expiry date so that whichever happens the return on the successful position is bigger than the cost of the other positions?

 

[OptionGuru]

1. Anybody recommend an options/futures broker offering demo account ?

Track the option chains on Yahoo Finance, maybe even setup a portfolio.

2. How can you calculate the risk to reward of an option and know the profit potential before entering?

Options 101 - Get a beginners book on options and look at the various positions. The R:R on most option trades can be calculated in your head.

3. would it be possible to develop a strategy consisting of buying cheap option positions for every scenario (bullish, bearish and neutral) all with the same expiry date so that whichever happens the return on the successful position is bigger than the cost of the other positions?

No ....... All option strategies carry a significant amount of risk. Hence the brokers disclaimers on their sites.

 

[K-Pia]

Hi all

A number of related questions:

1. Anybody recommend an options/futures broker offering demo account ?
2. How can you calculate the risk to reward of an option and know the profit potential before entering?
3. would it be possible to develop a strategy consisting of buying cheap option positions for every scenario (bullish, bearish and neutral) all with the same expiry date so that whichever happens the return on the successful position is bigger than the cost of the other positions?

1. Interactive Broker (Unlimited Demo)

 

[botpro]

3. would it be possible to develop a strategy consisting of buying cheap option positions for every scenario (bullish, bearish and neutral) all with the same expiry date so that whichever happens the return on the successful position is bigger than the cost of the other positions?

No, that's impossible, because in a neutral market situation _all_ of your options will lose.
From that logical view it follows that such a strategy covering all market situations and with a positive outcome simply can't exist.

 

[botpro]

2. How can you calculate the risk to reward of an option and know the profit potential before entering?

As already mentioned, you can find the equations in books specialized on options.
Or look for such calculators http://investexcel.net/probability-of-a-successful-option-trade/
(btw, I'm not sure but in one of the excel-sheets from that site I had found a bug, can't remember if the above one was affected).

Update:
yes, the buggy case is indeed the above case.
The last section is buggy. A correct calculation of the same example as on the above web page would give the following result:

Probability of Stock Expiring in Range    
Winning           Lower         Upper
Probability     Stock Price   Stock Price
  98%            $737.82       $1,355.34

Here's the fix for cell B23:
=EXP(($C$7)*SQRT($C$8/365)*-1*NORMSINV(A23))*$C$5

And here the fix for cell C23:
=EXP(($C$6)*SQRT($C$8/365)*NORMSINV(A23))*$C$5

 

[K-Pia]

Here is the book you should read.

 

[botpro]

No, that's impossible, because in a neutral market situation _all_ of your options will lose.
From that logical view it follows that such a strategy covering all market situations and with a positive outcome simply can't exist.

To the OP:

My above answer was for long options only.

If you use options selling (or a mixture of long and short) then it indeed could work out. But I haven't tested it.
Let us know of your results.

 

[Jebediah]

No, that's impossible, because in a neutral market situation _all_ of your options will lose.
From that logical view it follows that such a strategy covering all market situations and with a positive outcome simply can't exist.

Apologies, should have been clearer i meant neutral strategy in a volatile market.

In any event i hear what you are saying. There is no holy grail fit all strategy.

 

[Jebediah]

Here is the book you should read.

Ahh i have this book on an online database and will read it. Gracias

 

[redguld]

Thx i will read it