Hidden cost of replicating deltas thru options

G

GATrader

Hi y'all.

Was doing some spread comparos tonight trying to think of some spreads w/ diff payoff structures , risk reward to approximate a 100 shares of stock. Some strategies are basic such as verticals and some not so vanilla like embedded calendars with OTM calls,etc However, it occured to me that the cost of replicating 100 sh of stock , trader needs about 5-7 option contracts to get the deltas up to 100. Eg. 100 sh = 3 ATM verticals, or 100sh=10 wings,etc. What I just realized that the cost of replicating seems huge compared to being in a 100 sh position. HEre is how I came up with the breakdown and please tell me if I am way off. This assumes that I hit bid/take offer to get in/out of position.

100 sh Commish @ .005/share= $1 RT
100 sh vig when hitting bid/taking offer
(assuming NBBO is a penny wide) = $2

So the cost of getting into 100 sh of stock is $3.

To replicate same shares. Excluding deep ITM , trader needs about 5 options.

5 options @ $1.contract in and out= $10
5 option vig on a nickel wide spread
(buy/sell .025 over /under fair value)x 2 = 5x.025x2x100sh/cont=$25

total cost of getting into a spread to replicate 100sh = $35.

Is my math off? Thanks
 
Quote from GATrader:

Hi y'all.

Was doing some spread comparos tonight trying to think of some spreads w/ diff payoff structures , risk reward to approximate a 100 shares of stock. Some strategies are basic such as verticals and some not so vanilla like embedded calendars with OTM calls,etc However, it occured to me that the cost of replicating 100 sh of stock , trader needs about 5-7 option contracts to get the deltas up to 100. Eg. 100 sh = 3 ATM verticals, or 100sh=10 wings,etc. What I just realized that the cost of replicating seems huge compared to being in a 100 sh position. HEre is how I came up with the breakdown and please tell me if I am way off. This assumes that I hit bid/take offer to get in/out of position.

100 sh Commish @ .005/share= $1 RT
100 sh vig when hitting bid/taking offer
(assuming NBBO is a penny wide) = $2

So the cost of getting into 100 sh of stock is $3.

To replicate same shares. Excluding deep ITM , trader needs about 5 options.

5 options @ $1.contract in and out= $10
5 option vig on a nickel wide spread
(buy/sell .025 over /under fair value)x 2 = 5x.025x2x100sh/cont=$25

total cost of getting into a spread to replicate 100sh = $35.

Is my math off? Thanks
More...

you replicated initial deltas total , and not 100sh performance. What if stock moves 30% in your direction ? Will gains on 5 options replicate 100sh PnL ? No , the option's gains will be much larger.
 
Good point about how the position morphs from being 100 sh to much greater esp when u have long wings. That being said, if you are trying to capture a $2 move in the stock in a space of 1-2weeks, the vig might be too big to overcome if you stray away from a simple ATM put vertical sale (for bullish prediction)or ATM call vert sale (for bearish prediction)? $35 vs. $3 is a huge handicap. Do you have a suggestion on home to overcome such in trying to capture such stock moves? Thanks
 
Quote from GATrader:

Good point about how the position morphs from being 100 sh to much greater esp when u have long wings. That being said, if you are trying to capture a $2 move in the stock in a space of 1-2weeks, the vig might be too big to overcome if you stray away from a simple ATM put vertical sale (for bullish prediction)or ATM call vert sale (for bearish prediction)? $35 vs. $3 is a huge handicap. Do you have a suggestion on home to overcome such in trying to capture such stock moves? Thanks
More...

I don't think there is one firm answer to it. There will be a lot of trades-off when considering facts such as cost to carry , commish , spread vs. what ifs. You probably have to go case by case. Is 5 cents option's b/a spread on 200$ stock is the same as on 15$ ?
 
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