converting long calls to more bullish spreads

[xandman]

multiply the net delta for each structure by the price of the stock to get dollar delta. Or you can look at net delta as equivalent to holding the same number of shares in the underlying.

 

[rjjaz]

multiply the net delta for each structure by the price of the stock to get dollar delta. Or you can look at net delta as equivalent to holding the same number of shares in the underlying.

And then assumedly the higher one means more exposure to the stock and thus more bullish...

 

[xandman]

Yep. Next step, check your gammas to see how fast you pick up deltas as the underlying changes.

 

[rjjaz]

And then assumedly the higher one means more exposure to the stock and thus more bullish...

I hope you can check my logic/math here:

For example sake using round numbers, AAPL:
A) Long 140 of the Jun 2016 160's where delta is .1385; the net delta is thus 140 * .1385 or 19.39.

Converting to a bull call spread but more of them, buy 60 more of the 160's and sell 200 of the 175's
B) Long 200 of the Jun 2016 160's where delta is .1385; short 200 of the 175's where delta is .0726; the net delta is thus 200 * 0.0659 or 13.18.

Thus, the position has increased in quantity, but the net delta has significantly decreased as a %, so the long call was significantly more bullish than the new spreads even though there were more contracts in the spreads?

 

[xandman]

You multiply the net delta by the underlying price. So, a delta of 19 is like 19 shares of AAPL stock.

Spreading cuts your delta exposure significantly. Thats why you need to do significantly more spread lots to have the same exposure as a naked position.

Don't let the idea of commissions put you off to spreading. Other structures provide a more interesting risk reward than verts which seem like a waste of commissions.

 

[xandman]

I'm confused. Don't the more aggressive bullish positions have smaller deltas? In my example above, wouldn't then the spreads be more bullish?

They can be more aggressive inspite of having low deltas by having more gamma which is the growth multiplier for delta change as the underlying moves. ex ratio spread.

Also, you can have a very thin spread of 130 and 131 strikes. That spread would be incredibly levered to minute changes in the underlying. Spreads affect exposure and leverage.

 

[rjjaz]

They can be more aggressive inspite of having low deltas by having more gamma which is the growth multiplier for delta change as the underlying moves. ex ratio spread.

Also, you can have a very thin spread of 130 and 131 strikes. That spread would be incredibly levered to minute changes in the underlying. Spreads affect exposure and leverage.

I deleted my last post after rereading and researching net position delta, and so a movement of 19 shares of the underlying is certainly more aggressive than a movement of 13 shares.

However, in this scenario, I estimate that AAPL would have to exceed 188 or so to outperform the 160/175 spread and from my standpoint the trade off is worth capping gains at 175. Again in this hypothetical example - and perhaps goes back to the fundamentals of spreading in the first place vs. outright calls.

So converting the long 160's to long 160/175 spreads makes sense if the happy target is indeed 175 and not much higher by expiration (possibly lower than 175), and actually produces a higher return at the 175 target!

 

[ironchef]

The premium collected isn't worth the potential loss of profit.

That makes sense if the reason he is long AAPL is because he is bullish.

If already profitable, how best to hedge? Partial exit, roll up, credit spread, protective put...?

Thanks again.

 

[oldnemesis]

I don't want to add to the fog but I sometimes, if rarely, use vertical debit spreads to speculate on a rise in a stock's price.

If I buy a stock I am either speculating that the stock will rise in price at which point I will sell it, or I am collecting a dividend.

If I buy a call, since there is no chance to collect a dividend, I am purely speculating, not only that the stock will rise, but that the rise in the stock price will be greater than the price I pay for the call. OR I am speculating that the implied volatility of the call will rise and I will be able to sell the call for more than I paid for it sometime before expiration.

Buying calls rather than buying the stock allows me to speculate on a rise in stock price with a much lower investment (and thus higher potential yield) than buying the stock, but I have to pay time value for the call and the value of the call will deteriorate with time until expiration. At expiration all time value in the call will have expired and represent a loss unless the stock has risen in price so that the intrinsic value of the call has risen more than the time value of the call.

Thus a vertical spread compared to a straight call is a lower cost, capped speculation on a rise in price of the stock. A vertical spread is not an effective method of speculating on a rise in implied volatility since what is gained in price on the long option will usually (but not always) be lost in a parallel increase price in the short option which will net zero.

Of course, the main question is what is it that I know about the probability of a rise in stock price that is unknown to the rest of the world and thus not priced into the cost of the calls?

Unless I am an 'insider' or have an effective weegie board the answer is usually nothing.

Buying the call and at the same time selling a higher price call makes the same speculation as buying the call but both reduces the amount of the investment that needs to be overcome by a rise in intrinsic value and caps the possible rise in intrinsic value at the upper strike.

Buying a call is effective if the market has underpriced the call (Probability of a rise times the amount of the rise > price of the call).

Buying a spread is effective if the market has either underpriced the calls at the lower strike or overpriced the calls at the upper strike.

http://www.cboe.com/framed/IVolfram...ADING_TOOLS&title=CBOE - IVolatility Services

 

[ironchef]

Buying calls rather than buying the stock allows me to speculate on a rise in stock price with a much lower investment (and thus higher potential yield) than buying the stock, but I have to pay time value for the call and the value of the call will deteriorate with time until expiration. At expiration all time value in the call will have expired and represent a loss unless the stock has risen in price so that the intrinsic value of the call has risen more than the time value of the call.

oldnemesis. Here is a specific question:

If on May 6th one bought 1-20-16 $125 ATM Calls of AAPL @ ~$9. On May 22, AAPL was at ~$132 so he would have a gain of ~$6. At that point, he had a nice profit but still had a long way till expiration. He had the following options:

1. Do nothing and wait
2. Take partial profit, say sell half and keep the rest till later
3. Exit and call it a day
4. Take profit by roll up to another ATM Call say @ $132 strike
5. Convert the long call into a spread by selling either ITM, ATM or OTM calls, thus limit his profit but with additional lowering of his costs
6. Buy a protective put
7. Write a credit spread of equal # of contracts to lower my cost as a way for some protection
8. Do a ratio write, effectively create more credit spreads.....

The possibilities seem endless. What was the best path going forward? Recouped investment and let the rest run (what was the best path here) or exited and called it a day or did nothing?

If you were in that situation, how would you manage your trade?

Appreciate your comment and advice.