is this a valid strategy for options?

B

beachallstar

i have been developing a simple strategy for trend following with options and i was wondering if anyone could post some advice:

The valid point of using a trend indicator is: the stock is already gaining, so its doing what you want,appreciating in value.

The downside is if you trend follow with stock,and the market/stock turns against you you can get out with a very small(5%) loss

The downside with options is you can be wiped out very very easily.....so my strategy is like this

say i bought 25 calls PEP sept at 65 for 1.15 and 25 puts at 62.50 for 1.14 and PEP was trading at 64.20. would that be enough time for the stock to diverge in either direction to off set the call/put hedge and still profit?

I was also wondering if anyone knows and sites that screen delta/gamma so i can optimize this approach with a more volatile stock?:confused:
 
Quote from beachallstar:

say i bought 25 calls PEP sept at 65 for 1.15 and 25 puts at 62.50 for 1.14 and PEP was trading at 64.20. would that be enough time for the stock to diverge in either direction to off set the call/put hedge and still profit?
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It's easy to calculate:

Total cost for calls and puts = $2.29
Call strike $65.00 + $2.29 = $67.90
Put strike $62.50 - $2.29 = 60.21
Commission = ?????????


The stock must trade higher than $67.90 or lower than $60.21 to profit, plus enough to offset the commission. Looks like you need about a 5% move in either direction to break even.
 
ForexForex, your calculation applies ONLY at expiration.

beachallstar, this strategy is called a strangle and you can find a lot of info on it either here in the Options forum or using Google.
 
Quote from beachallstar:

say i bought 25 calls PEP sept at 65 for 1.15 and 25 puts at 62.50 for 1.14 and PEP was trading at 64.20. would that be enough time for the stock to diverge in either direction to off set the call/put hedge and still profit?

I was also wondering if anyone knows and sites that screen delta/gamma so i can optimize this approach with a more volatile stock?
More...
In a strangle, initially, what one side makes, the other side loses. Add time decay on two sides and you have a position that makes money only if the underlying moves. The longer it takes to move, the larger the move that you need to break even.

AFAIK, optimizing delta/gamma isn't going to help you much. Figuring out which stocks will move enough to offset 4 commissions (open and close 2 sides), lost B/A slippage and up to 2 months of time decay is your problem. Do that and you make money.
 
Quote from JPope:

I thought strangles were selling calls and puts, straddles we're buying?
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Nope. Strangles are when you use different strike prices - for example a 45 put and a 50 call. Straddles are when the strike price is the same (50 put/50 call).

Buying or selling has no bearing on the name (other then short/long).

JJacksET4
 
:) thanks for the help!

So does anyone know which works better,a straddle or a strangle? Is that dependant more on market enviornment? Because with a reasonable strangle you can be slightly more out of the money and get more leverage for your dollar.

But a straddle might have a higher probability because the strike price is the same for the call as it is for the put,so your only gap would be the bid/ask spread.

Does anyone trade options with 8 weeks of time value? That seems to me to give you more opportunity to offset your insurance side of your play and see profit.
 
Quote from beachallstar:

:) thanks for the help!

So does anyone know which works better,a straddle or a strangle? Is that dependant more on market enviornment? Because with a reasonable strangle you can be slightly more out of the money and get more leverage for your dollar.

But a straddle might have a higher probability because the strike price is the same for the call as it is for the put,so your only gap would be the bid/ask spread.

Does anyone trade options with 8 weeks of time value? That seems to me to give you more opportunity to offset your insurance side of your play and see profit.
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Timeline depends on the circumstance, Options are one of the most complex instruments to trade but in my opinion the most rewarding financially and intellectually stimulating if you get deep and get a good understanding, and a few years of experience.

Anyhow I have traded options with only a week and some days left to expiration, and sometimes LEAPS etc.. it all depends on the situation.

But you need to get to step one, and understand the underlying well before you even go to step two which is options.

Learn to crawl then walk before you go and run. Then it takes years.

I only focus on a very small handful of underlying, same ones for years, you do not want to be a jack of all trades master of none.
 
Quote from beachallstar:

So does anyone know which works better,a straddle or a strangle? Is that dependant more on market enviornment? Because with a reasonable strangle you can be slightly more out of the money and get more leverage for your dollar.

But a straddle might have a higher probability because the strike price is the same for the call as it is for the put,so your only gap would be the bid/ask spread.

Long straddles and strangles are a tough way to make money because the winning side has a delta of .50 or less and since the losing side is a drag on that reduced delta gain, the move has to be sizeable to get anywhere.

If there is a move, a "reasoanble" strangle won't do much worse than a straddle near term. Closer to expiration is a different story. So as you noted, the strangle will give you more bang for the buck on an equal dollar investment (leverage).


Does anyone trade options with 8 weeks of time value? That seems to me to give you more opportunity to offset your insurance side of your play and see profit.

Closer to expiration, positions cost much less and therefore the ROI will be much higher if the move occurs... as will the ROI loss if no move. It's all about timing.
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You're betting on a volatility spike. Best done, in my experience, a week or two before earnings, if you notice that volatility on the options is not out of line with normal despite earnings coming up soon.
Not an easy trade. Can be a huge moneymaker on a big miss or upside surprise, of course. Also, if volatility moves up before earnings, you could wind up making money even before earnings come out. Then you have to sit and wonder whether to cash it in or see if actual earnings wind up being a big enough surprise to make you even more money.
 
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