Long Call Verticals on LEAPS, legging out

C

cqm

Hello,

I am working out the kinks in a bullish strategy involving verticals in back month options, I'm looking at 12+ month time frames

Basically long OTM call, and short further OTM call

This gives a very cheap debit spread that allows you to get involved with MANY contracts for very cheap.

It gives only minuscule downside protection (to the entire position I mean, the entire position can take a loss quickly but it is nothing in compared to if you were only long that many contracts), but you also pick up theta decay from the short options if things don't move fast enough in your time frame


My problem is legging out, because it looks like too much leverage with my calculations.

The trading plan:
- Buy long OTM calls, sell short further OTM calls
- In the future, 6 months in, after some theta had some time to burn , if still bullish - close the short leg for 50-80% gain
- Average down on the long leg (the long leg will be loss making but acquirable for much cheaper, this gives you control over a lot more contracts)
- On the first uptick you make 50% gain (on the original principal used to open vertical position), on real bullish moves you make 4000% gains
- If market direction turns against you, 150% to 200% loss on original position. (due to averaging down the long calls that were diminishing in value) Capped loss. May mitigate this with a stop loss, but stops may be too tight when you have 4 months to go.


The "problem" is how much leverage this appears to be. Yet the risk is still sound, especially with any position sizing done

I have my backtest going that shows everything I just described (which is really what makes me skeptical), so I would like the community to illuminate some things about verticals that I haven't already considered
 
Quote from traderlux:

what underlies are you thinking about?
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high beta equities that I would be bullish about over the next 12 months
 
I don't know, one of the main advantages of deep OTM options is that they benefit greatly from Gamma and Vega increases even if it does not trade beyond the break-even at expiration. By using verticals, you hedge off most of the "convexity" and greatly limit your potential payoff. If you want to go deep OTM, why not just buy straight up calls or puts?
 
Quote from Robwynge:

I don't know, one of the main advantages of deep OTM options is that they benefit greatly from Gamma and Vega increases even if it does not trade beyond the break-even at expiration. By using verticals, you hedge off most of the "convexity" and greatly limit your potential payoff. If you want to go deep OTM, why not just buy straight up calls or puts?
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see this is the observation I am making.......


by doing a bull call spread you eventually get access to MORE contracts than you would have ever been able to afford initially.

Lets say the OTM call with 14 months to expiration is $22.00 on AAPL.

This requires initial capital of $2,200 per contract. You might pick up 10 of them and now have $22,000 in one position. You will be subject to theta and vega and 6 months down the line you will need a bullish move just to break even again because theta ate up your calls.

But by doing the bull call spread lets say the long call is $22.00 and the short call one further strike out the money is $21.50. Your entire position now costs $50. So with the same $22,000 that you would have allocated to 10 completely bullish contracts, you now have 440 long contracts and 440 short contracts

In a bearish, stagnant or only moderately bullish scenario, by six months in you will collect the theta from the short contracts and literally earn $20000...... your long contract will also have suffered from theta and especially at a lower support level the call will be at a 90% loss, USING THE PROCEEDS FROM THE SHORT LEG you can buy multiples more of the long contract, something you initially wouldn't have been able to afford. (if it was only a long call trade, then averaging down would feel unwise, you would consider having stopped out the trade initially, letting it expire worthless or rolling it into the future)

When you were only able to afford 10 contracts, now you can afford 120. So any place you were thinking about a 300% gain is now going to be a 3000% gain. Massive leverage created here, but your original risk profile hasn't changed, because this is part of the trading plan.

You still have a bullish attitude but just minuscule upticks at this point will give you gargantuan returns, and an actual bullish move or volatility increase in either of the two earnings seasons before expiration will greatly inflate the value here.

Also in a different scenario, where the stock was immediately bullish from when you initiated the bull call debit spread, the spread would still gain a lot of money like 400%.

In either scenario, the actual risk with no stops is still limited to 100% of the original capital used in the bull call debit spread. Although you will be throwing around much larger amounts.
 
Yes, you can put more contracts on, but you won't make anything until the underlying trades right up to the b/e point. With plan old deep OTM calls/puts, convexity can make them rise in value well before the underlying trades through the b/e point. More so if it's puts since you'll be almost certain to get an increase in vega.

Can you set up a p/l diagram in your broker's platform? I did one in TOS. I think you'll see what I mean.
 
Quote from cqm:

...USING THE PROCEEDS FROM THE SHORT LEG you can buy multiples more of the long contract, something you initially wouldn't have been able to afford...
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In order to make sure that I understand your method, let's use a specific example. You bought SPY 124 Call @ 8.57 and sold SPY 125 Call @ 8.06, so your net debit was 0.51, when the SPY was at 121.

A few months later, when the SPY was 112, you want to close only the short leg which is now worth 2.36, and buying more of the long leg which is now worth 2.65.

However, in order to close the short leg you would need to find somehow 2.36 to pay for that, which is 4.6 times higher than the original debit for your vertical, and also you would need to find 2.65 to increase your long position, which is 5.2 times higher than your original debit. I do not see how you can do it only from the proceeds of the short leg, and it seems to me that the only way you can do that is by adding new money.

And if you do so, you are just legging out of vertical and at the same time buying new long calls with substantial "new" money, and I am not sure that was your original intent, and also by that you may lose the substantial benefit of your original vertical (relatively small dollar amount at risk with high leverage).

Did I get you correctly or is there something that I am missing here?
 
Quote from Robwynge:

Yes, you can put more contracts on, but you won't make anything until the underlying trades right up to the b/e point. With plan old deep OTM calls/puts, convexity can make them rise in value well before the underlying trades through the b/e point. More so if it's puts since you'll be almost certain to get an increase in vega.

Can you set up a p/l diagram in your broker's platform? I did one in TOS. I think you'll see what I mean.
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I did simulations (both analyze and thinkback) in TOS which is why I am trying to get a second opinion. The numbers are too wild there has to be a catch.

I am going to paper trade a few simulations with weeklies to see if what I'm looking at is correct.
 
And if you do so, you are just legging out of vertical and at the same time buying new long calls with substantial "new" money, and I am not sure that was your original intent, and also by that you may lose the substantial benefit of your original vertical (relatively small dollar amount at risk with high leverage).

Did I get you correctly or is there something that I am missing here? [/B]
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well this is exactly what I wanted to hear

I am doing a simulation now with 2 separate verticals on FAZ and FAS weeklies to see how I would leg out

These two trades use all of the money in this paper account so I will see if it will let me close individual profitable legs whilst the other leg is at a loss.

Let you know in a few days!
 
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