Directional spreads
- Thread starter candeo
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Quote from optioncoach:
Stock is at $50 with high IV and 45 day $50 Call is trading at $5.00 while $50/$60 bull call spread is trading at $2.00.
Scenerio 1 - Buy Long $50 Call and by expiration, stock eventually moves to $56 by expiration and IV drops and you sell call for $6.00 for profit of $1.00
Scenario 2 - Buy Bull Call Spread for $2.00 and stock eventually moves to $56 by expiration and IV drops and you sell spread for $6.00 ( really only selling long call as short expires worthless) for profit of $4.00.
Assuming you did 10 spreads versus 10 long calls, spreads is much better risk/return and takes advantage of high IV rather than suffering from it.
Assuming you only wanted to spend $1,000 on the position you would do 2 long calls or 4 spreads and spread still comes out ahead.
I showed you an example. Have an open mind
Assume stock goes to $60 at expiration, spread still is better in this situation.
Well, of course...$2 spread and $5 call, with a $10 spread. If I pay $5 for the $50 call, my expectation is not for the stock to go to $56, or even $60. The risk/reward is just ridiculous. Thank you for the example, but if my target is $56, I won't consider the call, and I won't consider this spread either.
You asked for an example and I gave you one. I gave you a $60 price target which is a 20% move in the stock and quite significant and the spread still does better.
My guess is you feel the way you feel and would just ignore any example that might prove you wrong in certain situations by simply changing the parameters until only your answer is right.
Why bother asking the question then?
Spreads may be preferable over long calls or puts in situations of extremely high IV.
My guess is you feel the way you feel and would just ignore any example that might prove you wrong in certain situations by simply changing the parameters until only your answer is right.
Why bother asking the question then?
Spreads may be preferable over long calls or puts in situations of extremely high IV.
How did I know that you would take this one out of context as well and try to criticize?
I don't use probabilities to decide on where a stock is going. I get a signal from technical analysis, I enter the trade, set my stop, and my first target. In fact entry does not matter too much to me, so no, no probabilities. I then manage my trade with trailing stops. No probabilities here, so it is bad, right? This is one of my problems? I must probably be losing a lot of money trading like this. A problem you probably don't have as you must be a very rich and successful trader. I have no doubts about it.
Ok, I have wasted enough time with you tonight. I am going to have a nice dinner with my wife now. Have fun insulting someone else on your little board.
I agree $2 is probably an underestimation. I think $3.50 is a reasonable estimation for the bull call spread and the results are still the same.
Basically in a high IV situation a spread may perform better by reducing costs and negating vega to a large extent.
Basically in a high IV situation a spread may perform better by reducing costs and negating vega to a large extent.
Well, I already agreed about Vega risk in a previous post. That being said, your example is not very convincing. I am not saying this because I want to be right, but of course if stock does not go above the strike of the short call then the trade is better than the long call naked. I think we all understand that. If you are good enough to "guess" the range...but I think that you would agree that most of the time, picking such a far OTM call to short, you won't receive much. Is the small premium that you will receive worth giving up on the upside potential? Most of the time it is not. I don't have the time to make the calculation right now, I am already late, but from experience, even at $3.50 this spread seems very cheap compared to the price of the call for a 20% OTM short call.
The assumption was that IV was relatively high and you are locked into the assumed price of the bull call spread which is missing the main point. Use the $55 short strike instead if that makes it clearer. You are focusing on the actual premium and not the overall picture which is as follows:
In certain situations of high IV, a spread will do better than an outright call or put based on inflated premiums and vega risk. For example, if IV is high and skewed and you expect the stock to move to $60 from $50 near expiration, then an OTM $60 Call calendar will have a better risk/reward ratio then buying the outright $50 call. I dont need to put numbers in here, this is correct if you just think about the pricing of a $60 OTM call cal with an IV skew versus the long $50 Call and inflated IV.
Now if your premise is that the $50 stock is going to $75 then yes a long $50 call makes more than a $50/$55 bull call spread but not as much as a $70 OTM Call on same dollar value purchases
. The answer is always the same, it depends...
As I said, I could keep giving you examples but if you are not open to the idea you will not want to see how options are not blanket generalizations but that some strategies work better than others in certain situations.
In a historically low IV situation the outright call purchase for bullish trade might be better than the spread.
In certain situations of high IV, a spread will do better than an outright call or put based on inflated premiums and vega risk. For example, if IV is high and skewed and you expect the stock to move to $60 from $50 near expiration, then an OTM $60 Call calendar will have a better risk/reward ratio then buying the outright $50 call. I dont need to put numbers in here, this is correct if you just think about the pricing of a $60 OTM call cal with an IV skew versus the long $50 Call and inflated IV.
Now if your premise is that the $50 stock is going to $75 then yes a long $50 call makes more than a $50/$55 bull call spread but not as much as a $70 OTM Call on same dollar value purchases
. The answer is always the same, it depends...As I said, I could keep giving you examples but if you are not open to the idea you will not want to see how options are not blanket generalizations but that some strategies work better than others in certain situations.
In a historically low IV situation the outright call purchase for bullish trade might be better than the spread.