Introduction and backround. I think I have a good backround to have success

[Illini Trader]

I am a simple guy and I just keep it real simple. This trade is more likely to make money than lose money because the break even points are beyond the expected move by a decent margin, and the majority of stocks do not exceed their expected move.

I just like the comfort of this style of trading. A stock can sit still and it makes money. The stock can move up quite a bit and it makes money. The stock can move down quite a bit and it makes money.

It comes down to basic raw reality. Doing a strangle with OTM options in the last few days prior to expiration is a huge losing strategy. Then taking the opposite side is a winning strategy.

Theta Decay in the last few days of an options life is a killer to the option buyer. I want it on my side.

 

[JackRab]

It comes down to basic raw reality. Doing a strangle with OTM options in the last few days prior to expiration is a huge losing strategy. Then taking the opposite side is a winning strategy.

Theta Decay in the last few days of an options life is a killer to the option buyer. I want it on my side.

But make sure you buy the outside strangle, because those days will come when stocks move 20%. Market makers only know what everyone knows... we don't have a crystal ball unfortunately.

 

[Illini Trader]

@Illini Trader , that trade kinda makes sense. But it will depend largely on the fees involved as well. If you're paying 15-20 cents then I would say it's not worth it. If you hardly pay any due to providing the liquidity, then yes...

But you also have probably have to sit out the trade until expiry, since if the stock moves 1.80 either way, you're looking at a paper loss, depending on when. So what then...?

As @sle says, the odds are not great... but maybe in short term it might be warranted. You're right on not to do this at earnings.

"So What Then" There are ways to defend a trade that gets into trouble and my favorite is to add a debit spread to which ever vertical spread that gets into trouble thus turning it into a butterfly. This greatly reduces your max loss potential and sets up a situation where you might profit on both the vertical call spread and the debit spread.

In the CELG example assume CELG starts moving up. Then add the debit spread: +124 call and -126 call so it would max out at a $2.00 value if CELG closed at 126 or higher.

The butterfly would look like this. +124 call (2) -126 calls +128 call Now the ideal situation would be for CELG to close the week around 126

 

[Illini Trader]

But make sure you buy the outside strangle, because those days will come when stocks move 20%. Market makers only know what everyone knows... we don't have a crystal ball unfortunately.

That is why in a prior post I suggested to PM that he should only use 75K of his 1.2 M to do this.

 

[JackRab]

In the CELG example assume CELG starts moving up. Then add the debit spread: +124 call and -126 call so it would max out at a $2.00 value if CELG closed at 126 or higher.

The butterfly would look like this. +124 call (2) -126 calls +128 call Now the ideal situation would be for CELG to close the week around 126

But you would pay quite heavily for this spread... you're looking at 1.00+ ...

That is why in a prior post I suggested to PM that he should only use 75K of his 1.2 M to do this.

I didn't really read into OP's stuff.. since I got bored buy the whole card counting swap to daytrading stuff..

 

[Illini Trader]

But you would pay quite heavily for this spread... you're looking at 1.00+ ...

very true but your max loss is capped at that cost and the profit potential on the trade is enhanced

 

[ironchef]

I would think that if you are blindly buying or selling (no attempts to add some form of alpha), being net short risk premium would produce better risk-adjusted return, at least in terms of Sharpe and duration of drawdowns. That's why it's a risk premium (as in premium means it's more expensive then it should be).

Thank you for your reply.

Yes, it did not take me long to come to the conclusion that blindly buying did not work too well for me either. I need to include "judgement" to make money.

 

[MACD]

I don't understand why you think you have the odds on this trade. The expectation of being ITM is lower, but it's multiplied by the payout value that's high. The only way you have improved statistical expectation on this trade is if you are somehow predicting that the realized terminal distribution is going to be tighter then what the options market is forecasting. Are you doing any sort of analysis (for example, historical distribution analysis) for it?

SLE -- please translate into noobie speech what you just posted here in response to Ilini trader... Thanks.
Remember please that most here are not on the level of advanced statisticians or expert options mavins nor would I expect this would have much value for the OP

 

[sle]

SLE -- please translate into noobie speech what you just posted here in response to Ilini trader...

He's saying that the trade has good odds because the probability of reaching the strikes is low, as based on low delta of the options he's selling. I was just saying that while the the probability of reaching the strike is low, the loss should he reach the strike is big, so that makes the "odds" of winning on this trade rather un-intersting.

 

[Illini Trader]

@sle, Through the course of this discussion with you I have learned to respect your immense knowledge in the trading arena as if far surpasses my own. And, I understand totally why would feel as you do because at first blink the "reward" vs the "potential maximum loss" on any one trade might very much look "rather un-interesting"

But, you are looking at it from the outside in and don't see how these option trades develop and behave even when they go bad. The downside it not nearly as scary as it seems from where you sit. I had a trade this week that went totally off the rails and not only exceeded my sale strike price but also my protection strike. I would be willing to share the actual details how the trade worked out in real time if anyone cares.

In any regard, it is not about any one trade that might be a big loser, but the sum total of all trades taken together as it is I guess in anyone's trading style.