How bad can this option idea go? Billions in profit potential, but at what cost?

[Bum]

How does one develop a winning strategy with just a little knowledge of "premium"? I wish it is that easy to make a living trading options.

My quote: "trading call/put spreads can be done with a little knowledge of "premium"."

Trading spreads is just a simple method of using options but still requires knowledge of market direction, .....up...down....range. Spreads alone isn't a "winning strategy".

I think one of the better uses of spreads is just that it requires less capital & reduces risk.
Look at the examples below to compare "cost" and "loss".

You can have more spreads in other stocks with the "extra" cash you have now but be aware of the $$ loss in each trade & how that amount relates to your account size. Try to avoid doing too many % calculations when using options as it can be quite misleading. Focus on the $$ when looking at profit/loss potential in each trade.

Example #1:
GLD trading @ 143

Buy 100 shares of stock:
Cost....$14,300
GLD rises to 148.....Profit= $500
GLD rises to 150.....Profit= $700
GLD drops to 135....Loss= $800
GLD drops to 130....Loss= $1,300

Buy Dec. 140/148 Call Spread:
Cost.....$310
GLD rises to 148....Profit= $490
GLD rises to 150....Profit= $490
GLD drops to 135....Loss= $310
GLD drops to 130....Loss= $310

Example #2:
GDX trading @ 28.26

Buy 100 shares of stock:
Cost.....$2,826
GDX rises to 35....Profit= $674
GDX drops to 25...Loss= $326
GDX drops to 20...Loss= $826

Buy Dec. 24/35 Call Spread:
Cost.....$434
GDX rises to 35...Profit= $666
GDX drops to 25...Loss= $334
GDX drops to 20...Loss= $434

***These examples were done without looking at any of the "greeks". Purpose is just to show option spreads vs. stock purchase.
***These are not recommendations, just a quick glance to show as examples.
***Stocks can be purchased on "margin" at 2x so examples above are not margin calculations.
***Call spreads will only realize total profit if held till expiration but can be closed prior but less profit.
***To experienced options traders, sorry this was a waste of your time.
***This was done pretty quickly so possible to have mistakes.

 

[Option_Attack]

For struggling option traders here are some ideas to get you going. Very basic, but nothing wrong with that. First, here are some monthly 3rd Friday to 3rd Friday stats for DXD starting 10/19/2007 so covers some rough market times. As you may know DXD is the 3X Short Dow30 ETF. Others with less history are SDOW, SPXS, SPXU, etc. Varying liquidity, but plenty for the small trader. These ETFs drop of course from the near constant market uptrend, but also from daily mark losses. IOW these always drop, eventually, and usually sooner rather than later. Markets "take the stairs up," but "take the elevator down..." Turn that around for these ETFs.

DXD

TOTAL MONTHS = 143

DOWN MONTHS = 99
UP MONTHS = 44

%UP MONTHS = 31%
AVG PCT UP = 8.22

%DOWN MONTHS = 69%
AVG PCT DN = -6.16

AVG MONTHLY RETURN = -1.73
DROPS >= -8% = 26


UP IN A ROW

ONE IRUP = 25
TWO IRUP = 5
THREE IRUP = 3
FOUR IRUP = 0
FIVE IRUP = 0
SIX IRUP = 0
SEVEN IRUP = 0
EIGHT IRUP = 0
NINE IRUP = 0
TEN IRUP = 0


DOWN IN A ROW

ONE IRDWN = 12
TWO IRDWN = 7
THREE IRDWN = 5
FOUR IRDWN = 2
FIVE IRDWN = 2
SIX IRDWN = 1
SEVEN IRDWN = 2
EIGHT IRDWN = 0
NINE IRDWN = 1
TEN IRDWN = 0

Seeing these stats, wonder how writing a bear call (credit) vertical every month would do? If the short call was about 80 delta and the long was about 40 delta, and only a couple (typically) strikes apart, these spreads would have a 50/50 or better risk/reward. IOW no big deal if it goes wrong. Watch for EX Div dates tho, don't want early assignments. If you win on it, and you will a lot, no closing costs if the strikes move OTM. If you lose, and you will some, just close the spread near expiry for a little over. I haven't had a problem getting them closed even when buried DITM. If you try the monthly condor thing on SPX this is similar but I believe safer and easier.

So how to test this idea without spending a bundle? Go here and sign up for the 14 day free trial. This easy to use back tester should give you plenty of ideas for improvement of this simple idea:

https://www.elitetrader.com/et/resources/orats-wheel.484/

How does one develop a winning strategy with just a little knowledge of "premium"? I wish it is that easy to make a living trading options.

 

[ironchef]

Trading spreads is just a simple method of using options but still requires knowledge of market direction, .....up...down....range. Spreads alone isn't a "winning strategy".

I think one of the better uses of spreads is just that it requires less capital & reduces risk.
Look at the examples below to compare "cost" and "loss".

Thank you. So for every underlying, there are many ways to trade: Underlying, margins on underlying, future, option on future, option, combination options etc. Which is better? Better odds, higher payout, lower risk? I need more than a cursory understanding to select the best ? approach each time?

Spreads alone isn't a "winning strategy".

This reminded me of what some of the old timers drilled into me. @Maverick74 liked to say there is no edge buying or selling options, spread, butterfly...., everything is priced in. So, how do we make money trading options?

In the long run do we have to be more right than wrong to make $? Or is there another way?

 

[ironchef]

For struggling option traders here are some ideas to get you going. Very basic, but nothing wrong with that. First, here are some monthly 3rd Friday to 3rd Friday stats for DXD starting 10/19/2007 so covers some rough market times. As you may know DXD is the 3X Short Dow30 ETF. Others with less history are SDOW, SPXS, SPXU, etc. Varying liquidity, but plenty for the small trader. These ETFs drop of course from the near constant market uptrend, but also from daily mark losses. IOW these always drop, eventually, and usually sooner rather than later. Markets "take the stairs up," but "take the elevator down..." Turn that around for these ETFs.

DXD

TOTAL MONTHS = 143

DOWN MONTHS = 99
UP MONTHS = 44

%UP MONTHS = 31%
AVG PCT UP = 8.22

%DOWN MONTHS = 69%
AVG PCT DN = -6.16

AVG MONTHLY RETURN = -1.73
DROPS >= -8% = 26


UP IN A ROW

ONE IRUP = 25
TWO IRUP = 5
THREE IRUP = 3
FOUR IRUP = 0
FIVE IRUP = 0
SIX IRUP = 0
SEVEN IRUP = 0
EIGHT IRUP = 0
NINE IRUP = 0
TEN IRUP = 0


DOWN IN A ROW

ONE IRDWN = 12
TWO IRDWN = 7
THREE IRDWN = 5
FOUR IRDWN = 2
FIVE IRDWN = 2
SIX IRDWN = 1
SEVEN IRDWN = 2
EIGHT IRDWN = 0
NINE IRDWN = 1
TEN IRDWN = 0

Seeing these stats, wonder how writing a bear call (credit) vertical every month would do? If the short call was about 80 delta and the long was about 40 delta, and only a couple (typically) strikes apart, these spreads would have a 50/50 or better risk/reward. IOW no big deal if it goes wrong. Watch for EX Div dates tho, don't want early assignments. If you win on it, and you will a lot, no closing costs if the strikes move OTM. If you lose, and you will some, just close the spread near expiry for a little over. I haven't had a problem getting them closed even when buried DITM. If you try the monthly condor thing on SPX this is similar but I believe safer and easier.

So how to test this idea without spending a bundle? Go here and sign up for the 14 day free trial. This easy to use back tester should give you plenty of ideas for improvement of this simple idea:

https://www.elitetrader.com/et/resources/orats-wheel.484/

If it is consistent, why doesn't the market arbitrage this away, I wonder?

 

[bln]

there is no edge buying or selling options, spread, butterfly...., everything is priced in. So, how do we make money trading options?

You do it by correctly calling what the underlying will do in X amount of time?

a) sharply up b) slightly up c) sideways d) slightly down e) sharply down

You can structure a options position to win if one or multiple of these are true or not true. There is one or more option positions that fit every possible scenario.

 

[ironchef]

You do it by correctly calling what the underlying will do in X amount of time?

a) sharply up b) slightly up c) sideways d) slightly down e) sharply down

You can structure a options position to win if one or multiple of these are true or not true. There is one or more option positions that fit every possible scenario.

Me and thousands of professional, institution and hedge fund traders are all doing the same, so the most probable outcome is priced in. If I do enough trades, probability says I will come out a loser. The key then is to make one bet (or a few) and if I win, I quit.

 

[bln]

Me and thousands of professional, institution and hedge fund traders are all doing the same, so the most probable outcome is priced in. If I do enough trades, probability says I will come out a loser. The key then is to make one bet (or a few) and if I win, I quit.

Maybe the majority does the same. If a instrument has five different possible outcomes, sure majority will be betting on a few of these, does it really matter. Sometimes the probable outcome will win, sometimes it will not. You do your analysis that you are confident in that tilt the odds in your favour, then trade that analysis with conviction regardless of what other people do you will be a winner.

 

[ironchef]

Maybe the majority does the same. If a instrument has five different possible outcomes, sure majority will be betting on a few of these, does it really matter. Sometimes the probable outcome will win, sometimes it will not. You do your analysis that you are confident in that tilt the odds in your favour, then trade that analysis with conviction regardless of what other people do you will be a winner.

But but but. If the majority came out with the same probability as I and that is the most likely outcome, then the price was already priced into what I traded so I would net zero - commission - slippage. To come out ahead, I have to be right and the majority wrong.

 

[bln]

But but but. If the majority came out with the same probability as I and that is the most likely outcome, then the price was already priced into what I traded so I would net zero - commission - slippage. To come out ahead, I have to be right and the majority wrong.

I "believe" successful methods are often contrarian in them self towards the majority. Smart money load up against majority order flow to position them self early on the trend reversal. And the reverse, distributing their position against majority order flow to exit or initiate trades in opposite direction.

Just develop/build a statistically validated method that produces alpha that you are confident in and get your hands dirty trading, don't over complicate things.

 

[ironchef]

I "believe" successful methods are often contrarian in them self towards the majority. Smart money load up against majority order flow to position them self early on the trend reversal. And the reverse, distributing their position against majority order flow to exit or initiate trades in opposite direction.

Just develop/build a statistically validated method that produces alpha that you are confident in and get your hands dirty trading, don't over complicate things.

It takes skill to create Alpha, since I don't have any, I just loaded up Beta and rode the market.