Long Calls/Puts vs. Spreads (Long on the Wings)

Quote from dmo:

Exactly correct. Then once I get the implied volatility for the ATM options, I have a baseline against which I can compare other options to see if they are relatively "cheap" or "expensive."

I'm only interested in whether options are cheap or expensive compared to each other, not compared to the actual volatility of the underlying security. Not that it would be impossible to construct a strategy based on comparing IV to actual volatility, it's just very difficult because the volatility that matters is the volatility that WILL exist from now until expiration, and how do you know what that will be?

But if you do have reason to believe that future volatility will be different from existing volatility and - more to the point - from existing implied volatility, then that is certainly a legitimate play.
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Many thanks. I'm curious do you trade equity options or futures options. if both, which is your major focus?
 
My background is in futures options, and I'm much more comfortable in that world. It's probably just a matter of what you're used to, but I find many things about stock options that turn me off. Shorting the underlying to hedge your options can be difficult or impossible. On low-cost stocks the strikes are so far apart that there are essentially no options to trade or at the very least, no options to spread against. Instead of risk margining, there is some irrational and incomprehensible set of margining rules. You have dividends to complicate things. Instead of the transparency of one exchange and one clearing house handling all trades in a contract, there is a mish-mash of exchanges connected in a way that nobody understands. Supposedly everyone gets the national best bid and offer, but with institutions paying for order flow I doubt it. In stocks you are competing against insider information in a way that doesn't exist in futures.

On the other hand, I have to admit that electronic trading is infinitely more advanced and convenient on stock options than on futures options. To reasonably trade many spreads in many pits, you really have to be able to call a broker directly in the pits, which not everyone can do.
 
Thanks, dmo. I'm interested in futures options, so that's good as your experiences are therefore more directly related.

I have traded futures for many years, but now wish to expand to futures options as I believe there are great benefits here.

A few questions, if I may from another thread I started. Please assit with answers, if you can. Thank you much!


1. What is the best platform for futures options tradeing. Ideally the platform should have in-built tools, calculators, greeks, historical data, etc.

2. How liquid are the E-mini S&P options? Are they liquid overnight?

3. Are the big S&P options liquid overnight when they trade on GLOBEX?

4. How easy is it to submit spread orders for futures options: straddles, strangles, iron condors, etc. Playing aorund with the TOS demo platform it seems even basic spreads are not accepted?

5. Have people had better experience with pit trading or electronic for options i.e. for the S&P is it better to trade the big S&P via the pit or the e-mini electronically on GLOBEX?

6. What are compettive commission rates?

7. What have been people's expereices with the EOM E-mini S&P options. They seem quite illiquid.

8. Apart from the S&P what are the other liquid futures options?

9. Some have recommened the Hoadley options tool? Any other recommendations for options tools?
 
I entered a debit strangle spread (atm bull call spread & atm bear put spread) on AAPL today, as earnings are tomorrow. To test the extreme effect of slippage, I entered at market. Bull call spread: Nov 100/105 (8.80/6.65); Bear put spread: Nov 95/90 (10.30/8.00).

It's a matter of wait & see.

Question: If the short side of a debit vertical spread is itm, will the broker exercise the short leg (which may trigger a margin call)? I understand the issue with a credit spread that goes itm; however, I certainly hope that would not be the case with a debit spread that goes itm.

Walt
 
Your AAPL spread picture looks interesting. Theoretically, there is a place between 95 and 100 where you could lose everything ($4.45 ), but with earnings and the craziness in the market, that is unlikely at NOV expiry, I think. The only unfortunate thing is that the most you can realistically make is about 4.90 after slip and commissions. That's 0.45, or just a hair over 10% max gain, so yes, you are likely to win, but only make a modest gain.
 
Quote from jones247:

Question: If the short side of a debit vertical spread is itm, will the broker exercise the short leg (which may trigger a margin call)?

I understand the issue with a credit spread that goes itm; however, I certainly hope that would not be the case with a debit spread that goes itm.

Walt
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1) The broker NEVER initiates an exercise. Only the option owner may do that.

2) It is very (very very) unlikely that anyone will consider exercising an option prior to expiration.

First, they lose all remaining time premium in the option - and why do that?

Second, exercising a call is folly because the exerciser buys stock and pays interest to hold it. No one does that (except to collect a dividend).

Puts do get exercised prior to expiration, but they must be deep in the money - and even then it does not always happen.

Third, if you own an option your loss is limited. If you exercise and the stock reverses direction you can lose a bundle. No one in his right mind would place himself in such jeopardy.

3) You can eliminate the margin call quickly - just exercise your long option and lock in the maximum possible profit.

Mark
 
Quote from JohnGreen:

Your AAPL spread picture looks interesting. Theoretically, there is a place between 95 and 100 where you could lose everything ($4.45 ), but with earnings and the craziness in the market, that is unlikely at NOV expiry, I think. The only unfortunate thing is that the most you can realistically make is about 4.90 after slip and commissions. That's 0.45, or just a hair over 10% max gain, so yes, you are likely to win, but only make a modest gain.
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The 10% gain may be modest, but I don't know of a higher probability play with better returns. Is there a better way to play earnings probability? If I was more strict with my orders, I would be able to make 20% max gain. That's a pretty solid return for one month.
 
Quote from dagnyt:

1) The broker NEVER initiates an exercise. Only the option owner may do that.

2) It is very (very very) unlikely that anyone will consider exercising an option prior to expiration.

First, they lose all remaining time premium in the option - and why do that?

Second, exercising a call is folly because the exerciser buys stock and pays interest to hold it. No one does that (except to collect a dividend).

Puts do get exercised prior to expiration, but they must be deep in the money - and even then it does not always happen.

Third, if you own an option your loss is limited. If you exercise and the stock reverses direction you can lose a bundle. No one in his right mind would place himself in such jeopardy.

3) You can eliminate the margin call quickly - just exercise your long option and lock in the maximum possible profit.

Mark
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Thanks for the feedback Mark,

I meant "assign" by the broker, not exercise. I guess ultimately, I'm concerned about early assignment before expiaration. My debit spread won't reach its full potential until expiration; however, if both legs are itm prior to expiration, althought it's a debit spread, I'm concerned about the broker issuing a margin call on the short leg. If that were to happen, I will be forced to close my long position; however, I will then forfeit the full potential of the debit spread.

Am I wrong with my understanding?

Thanks,

Walt
 
Perhaps the best way to mitigate the risk of early assignment & to reduce the impact of slippage is to set up the bull call spread and the bear put spread with the long legs atm and the short legs 2 strikes away (instead of only 1 strike price away). Instead of a max 20% return, it would be a max 30% return (assuming that I establish my positions thru limit orders). If my limit orders fail to get filled, then I simply won't take the trade.

The obvious downside to this is that instead of paying $4.00+ for $5.00 max, I'd be paying $7.00+ for $10.00 max. What can you say... no free lunch... Nonetheless, I don't know of a better probability trade with a higher ROI. Afterall, I can still manage and minimize my risk.

Walt
 
Quote from jones247:

Thanks for the feedback Mark,

I meant "assign" by the broker, not exercise.

I guess ultimately, I'm concerned about early assignment before expiaration. My debit spread won't reach its full potential until expiration;

Am I wrong with my understanding?

Thanks,

Walt
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Walt,

When you you buy a spread - debit spread - and the options move into the money, smile.

If you are assigned, then all you have to do is exercise and you have collected the MAXIMUM value for the spread. You win. And you have the best possible result. And the position is closed. Period.

To prevent that margin call, exercise as soon as you learn of the assignment. That means exercise when the market opens.

It is more intelligent to wait until day's end before exercising - you never know - the option may suddenly move OTM and you reap a bonanza. But if a margin call is your concern, exercise and that's the end of it.

Again, the option owner makes exercise/assignment decision. The broker does not (although they must allocate assignment notices among their customers).

It's different with a credit spread, buy with a debit spread, early exercsie is a gift. A gift. Take it.

Mark
 
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