Directional spreads

daddy'sboy · May 28, 2007

Quote from asap:

there are some problems with the spread approach when applied to your strategy. first, you are not sure of when the price move will happen. with spreads, either you chose hi leverage bets in front month or low leverage bets in back month. since you'd like to have both (that is, hi leverage and wider time frame), then the spread strategy might be suboptimal. doing hi leverage front month spreads and rolling them is dangerous, because, you might end up with a full loss even with neutral price action or slight positive drift, while with the itm outright, you'd always, at least, break even. if you chose a back month spread instead, you wont get as much bang for the buck and, in addition, if the price moves aggressively in your favor you have a nasty cap to your profit potential and hi rolling costs.

all this is based on the assumption of expecting "home runs" (ie merger announcements), which statistically, could be described as bell curve outliers. in my opinion, the best way to capture these outliers in a risk conscious manner is through itm outright because you have some downside protection, while maintaining the full payoff potential.

conversely, if what you refer as "home runs" are just normal statistical results and thereby already priced in contracts, then you could most probably optimize your strategy using spreads. the sweet spot for these spreads would be front months with approx risk:reward ratio of 1 to 2. i can explain why in a later post. now i head to bed, as i am across the atlantic.

Could you please clarify what you mean by 'itm outright'? Are you referring to the vertical? If so then how much itm?
Thanks.
db

candeo · May 28, 2007

MTE, what I meant was rolling the short call to a higher strike as the price of the underlying approaches the strike, to keep taking advantage of the move.

candeo · May 28, 2007

asap, my strategy with the spreads would be to do it with Leaps, as you are right, I don't know when the move would happen. Anyone here doing this kind of trade? I have done calendars when I buy Leaps and sell front month every month. Many times the sale of the front months, every month, allowed me to own the Leaps for free after 3-4 months. But I have never done verticals, same month different strikes, on DITM Leaps, rolling the short calls as price gets closer.
Seems like it might be a good directional strategy, lowering the risk of vega.

candeo · May 28, 2007

Mushin,

I take care of the "FDA, earnings, bad news" with money management/ position sizing. It is part of my directional strategy, the most important part in fact. Doing a vertical spread does not eliminate this risk, and certainly in no way that position sizing can't deal with. I think it is an error to think that spreads limit this kind of risk.

candeo · May 28, 2007

Quote from atticus:

I was long >100 NDX 1800/1900/2000 flies at $32 [average] basis the natural fly debit. Sold in ~10 days at $49. The fly was $.80 wide.

Selling equivalent deltas in buying the ATM put would've earned $9 over the same duration.

$9 < $17

??? A butterfly is not a directional spread.

atticus · May 28, 2007

Quote from candeo:

??? A butterfly is not a directional spread.

lmao. "Directional" is defined by delta. I was short thousands of deltas. I am considering this gag as my sig-line: I never understood why people would even consider simple 2 legs vertical spreads

candeo · May 28, 2007

Quote from atticus:

lmao. "Directional" is defined by delta. I was short thousands of deltas. Ignorance is bliss.

I think you know exactly what I mean, no need to be a smart ass. The goal of a butterfly is to achieve a price target at expiration, or be as close as possible to it. if you don't see the difference between this and a truly directional spread such as a vertical, then you are right, ignorance is bliss. All spreads can be designed to not be delta neutral, it does not mean that the goal of the spread is for the underlying to strongly go one way.

atticus · May 28, 2007

Quote from candeo:

I think you know exactly what I mean, no need to be a smart ass. The goal of a butterfly is to achieve a price target at expiration, or be as close as possible to it. if you don't see the difference between this and a truly directional spread such as a vertical, then you are right, ignorance is bliss. All spreads can be designed to not be delta neutral, it does not mean that the goal of the spread is for the underlying to strongly go one way.

Keep digging that hole deeper. Consider an otm fly... spot at 100, the trader buys the 105-115-125 fly at $.20. You don't consider a move to neutrality [115] as directional?

candeo · May 28, 2007

Quote from atticus:

lmao. "Directional" is defined by delta. I was short thousands of deltas. I am considering this gag as my sig-line: I never understood why people would even consider simple 2 legs vertical spreads

Good for you. Your life must be very sad for you to spend your time attacking and insulting people on a message board.

atticus · May 28, 2007

Quote from candeo:

Good for you. Your life must be very sad for you to spend your time attacking and insulting people on a message board.

You're especially pompous and ignorant. Which makes it somewhat pleasurable. Done yet?