Directional exposure with Futures, Vanilla Options, Risk Reversal, or Synthetic?

G

Global OptionsTrades

Been thinking through various permutations of directional exposure. I would be grateful for any steer from the seasoned guys on here.

For context, my journal on here ( https://www.elitetrader.com/et/threads/global-options-trades.330518/ ) shows that I frequently take a directional position on an index (or currency or commodity) via a combination of AtM vanilla options and OotM vanilla options, which I typically hold for 20-30 days. Downside is obviously limited to the premium paid, which I'm comfortable with but wondering if there is a better way.

Future
I'm not in favour of using futures alone, as historically I found stops often provide the required protection at the wrong time(!) (a correct call is stopped out during the trade) and I don't want unlimited risk of trading futures without downside protection.

Vanilla Option
Simple vanilla AtM and OotM options give me the exposure I want, and a reasonable P&L, with occasional total loss when my directional calls are wrong, but I'm keen to explore better ways of using the tools available.

Risk Reversal
Entering a trade with negligible cost is of course interesting, but I'm petrified of unlimited downside risk with Risk Reversals, and unsure of the merits of opening a Risk Reversal with a protective long OotM position on the short side? I guess as a trade, this is more suited to capturing short-term (intraday) moves?

Synthetic
This really appeals, as I get directional exposure with a Future, and downside protection with a long Option in the other direction, which can be placed with expiry slightly OotM (where I would have placed a conventional stop loss), thus costing less premium that I currently pay for AtM. Three queries with this:
  1. It seems better to buy weekly options and (if the directional call is correct) enjoy a 'trailing stop' effect of protective options that follow the future and lock in gains, than to buy the protective option with expiry over expected trade duration (a couple of months out). Any thoughts?
  2. Is there a way to specifically enter this trade using IB? I guess not, so one buys Futures and Puts (or sells Futures and buys Calls) in separate transactions and IB sorts out the margin (Portfolio Margin account).
  3. What am I missing? Directional exposure with affordable protection and locked-in profit seems too good to be true, and we all know what that means!
Thanks in advance.
 
Global OptionsTrades said:
Synthetic
This really appeals, as I get directional exposure with a Future, and downside protection with a long Option in the other direction, which can be placed with expiry slightly OotM (where I would have placed a conventional stop loss), thus costing less premium that I currently pay for AtM.

Three queries with this

... What am I missing? Directional exposure with affordable protection and locked-in profit seems too good to be true, and we all know what that means!
More...

Andy

Why bother with the combo long future / long put option
... when you could just buy the call ( at same strike / expiry as Put ) as equivalent trade

Cheers
James
 
Choice of instrument is a function of your ability to predict the variables that contribute to the pricing of that instrument. Futures are a bet on direction ie skewness of future price distribution, but options are a bet on volatility ie dispersion of future price distribution. Which of these do you have an edge in predicting?

It seems to me you're trying to square the circle by eliminating the need to predict something - but that's not possible, or at any rate it's not free.
 
jamesbp said:
Andy

Why bother with the combo long future / long put option
... when you could just buy the call ( at same strike / expiry as Put ) as equivalent trade

Cheers
James
More...

Hi James,

Good question.

A long ItM Options would obviously have a higher entry cost than the AtM, which would impact P&L%, but would have intrinsic value immediately.
 
Specterx said:
Choice of instrument is a function of your ability to predict the variables that contribute to the pricing of that instrument. Futures are a bet on direction ie skewness of future price distribution, but options are a bet on volatility ie dispersion of future price distribution. Which of these do you have an edge in predicting?

It seems to me you're trying to square the circle by eliminating the need to predict something - but that's not possible, or at any rate it's not free.
More...

Thanks @Specterx . To answer your question, I'm more comfortable with direction than volatility.

I'm fully aware that there is no free lunch - just wondering whether there is a better method of benefitting from price movement when I'm right, whilst limiting downside when I'm not, than AtM and OotM vanilla options.
 
Global OptionsTrades said:
A long ItM Options would obviously have a higher entry cost than the AtM, which would impact P&L%, but would have intrinsic value immediately.
More...

The long future / long OTM put combination is the equivalent to long ITM call

The 'intrinsic' is the same for both strategies ... if you don't think this is the case ... pop both strategies into some form of analyser and check.
 
I've got a suggestion. You go long a high beta index future and short a lower beta index future in dollar volatility adjusted ratio.

Then you are both long and short but at the same time you are in a bullish position.

The equivalent options position (i.e. synthetic) is to

Long Call / Short Put ATM (Higher Beta INDEX)
Long Put / Short Call ATM (Lower Beta INDEX)

This is called an index spread. It is a relative value trade. A flexible position, that is also adaptable to events as they unfold.
 
Real Money said:
I've got a suggestion. You go long a high beta index future and short a lower beta index future in dollar volatility adjusted ratio.

Then you are both long and short but at the same time you are in a bullish position.

The equivalent options position (i.e. synthetic) is to

Long Call / Short Put ATM (Higher Beta INDEX)
Long Put / Short Call ATM (Lower Beta INDEX)

This is called an index spread. It is a relative value trade. A flexible position, that is also adaptable to events as they unfold.
More...

Thanks @Real Money

The Index spread is not something I had considered before so will do some research and modelling.
 
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