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

jones247 · Oct 18, 2008

Quote from dmo:

Overcoming slippage is always a problem. But why would it be significantly worse than for other multi-legged spreads?

It's no worse than other multi-legged spreads. The problem with a six-legged transaction (enter & exit) is that it's more theoretical than realistic. How many six-legged positions, that are entered into and exited, are able to overcome slippage?

It seems like an infeasible type trade because of slippage. Perhaps trading such a strategy with SPY would be possible, but that's about it I would think.

Walt

sonoma · Oct 18, 2008

Quote from jones247:

It's no worse than other multi-legged spreads. The problem with a six-legged transaction (enter & exit) is that it's more theoretical than realistic. How many six-legged positions, that are entered into and exited, are able to overcome slippage?

It seems like an infeasible type trade because of slippage. Perhaps trading such a strategy with SPY would be possible, but that's about it I would think.

Walt

Don't put this on all at once. The object is to work your inventory into this position over time.

CPTrader · Oct 19, 2008

Quote from dmo:

Right, that's what I said - " If you do it in such a ratio that you are vega neutral" - which equals gamma neutral and theta neutral provided all your options have the same expiration date. That means being long more wings than you are short the middle.

Naked long straddles are completely different in that they are pure long-premium plays. Every day that the underlying doesn't move you lose money - more today than yesterday, and more tomorrow than today.

But if you start off short the middle and long the wings at a ratio that makes you gamma, vega and theta neutral, then if the underlying doesn't move, you get shorter and shorter premium (make more and more money) every day. If the futures DO move, you get long premium, which is usually just what you want. So this position has you short premium if the underlying doesn't move, and long premium if the underlying does move. It has you short premium if IV goes down, and long premium if IV goes up. These are exactly the characteristics you want in an option position. It is a very, very comfortable position to have. But comfort comes at a price. That's why those wings are expensive.

Interesting thread. Thanks to all for sharing.

dmo, can you please guide me to a website or software that I can use to construct such a position where I am gamma/vega/theta neutral. I know the strikes I have in mind, but I'm unable to detrmine the appropriate ratios/quanitites for each leg as I don't have access to the greeks for each option.

Thanks in advance for your help.

CPTrader · Oct 19, 2008

A basic question: If an option spread position is constructed at a debit, i.e. you outlay premium to put on the spread, is your maximum risk always limited to the premiuum paid/ i.e. the initial debit?

dmo · Oct 19, 2008

Quote from CPTrader:

Interesting thread. Thanks to all for sharing.

dmo, can you please guide me to a website or software that I can use to construct such a position where I am gamma/vega/theta neutral. I know the strikes I have in mind, but I'm unable to detrmine the appropriate ratios/quanitites for each leg as I don't have access to the greeks for each option.

Thanks in advance for your help.

Google "option calculator" and you'll find thousands of them, such as http://www.optionseducation.org/quotes/default.jsp Before trading it I would verify on a few such calculators that they agree. But you should really have your own software that you know and feel comfortable with so you can manage your position on an ongoing basis. I use the Hoadley package, I'm sure there are many others.

dmo · Oct 19, 2008

Quote from sonoma:

Don't put this on all at once. The object is to work your inventory into this position over time.

Right, well said. Occasionally prices may be so out of whack that you can just put this on, but more often it is something you work your way into over time if the opportunity presents itself

mike007 · Oct 19, 2008

Quote from CPTrader:

Interesting thread. Thanks to all for sharing.

dmo, can you please guide me to a website or software that I can use to construct such a position where I am gamma/vega/theta neutral. I know the strikes I have in mind, but I'm unable to detrmine the appropriate ratios/quanitites for each leg as I don't have access to the greeks for each option.

Thanks in advance for your help.

Thinkorswim's software does it all.

dagnyt · Oct 19, 2008

Quote from CPTrader:

A basic question: If an option spread position is constructed at a debit, i.e. you outlay premium to put on the spread, is your maximum risk always limited to the premium paid/ i.e. the initial debit?

NO.

The answer is yes if you buy a call or put spread where both options expire in the same month. Or if you pay a cash debit for a calendar spread. Or buy a butterfly, etc.

But if you have something more complex, such as a diagonal spread, you can lose more than your debit.

Example:

Sell Nov 95 call
Buy Dec 100 call

Debit: $3.00

Theoretically, this spread can move to a value of $5 - and it would cost another $5 to exit. Total loss $8.

How can this happen? If the stock runs to $150 and if the implied volatility is crushed, the Jan call could be trading near parity. The Nov call would be $55 when the Dec call could be $52. Cost to exit: another $3.

Mark

CPTrader · Oct 19, 2008

Quote from dmo:

Google "option calculator" and you'll find thousands of them, such as http://www.optionseducation.org/quotes/default.jsp Before trading it I would verify on a few such calculators that they agree. But you should really have your own software that you know and feel comfortable with so you can manage your position on an ongoing basis. I use the Hoadley package, I'm sure there are many others.

Thanks!

With the Hoadley pakcage, do you supply your own volatility estimates & interest rate estimates or does the package have its own source for volatility. What's the data source for these calculators - user supplied or software supplied? If user supplied, where can I get good options data?

Thanks again!

JohnGreen · Oct 19, 2008

Walt,
Just a quick note-- Nassim likes to finance his position with CREDIT spreads, not debit spreads. There is a crucial difference between the two, and slippage is not a problem on exit for many of the spreads because half of them will likely expire worthless! With a good broker (TOS or IB), entry slippage can be minimized to between 0.05 and 0.10 most of the time with modest sized positions. You make an offer at your price, don't just take any price--you can choose not to buy if they're unwilling to sell at a reasonable price.

To give an example of how such spreads can be constructed is to set up an IC (for a credit obtained), then buy way OTM debit spreads (but a few more of them) using much , but not all of the credit obtained to finance the purchase. This position will require watching and management, but a huge price change in the underlying will not necessarily blow you out of the water because you have the wings to protect you.

Comments anyone???