Let's see if I have this right. First, you're going to buy ITM verticals because their hedge compensates for your not being very good at stock timing and direction. Then, you're going to violate the Constructive Sale rule and cover the short call to take a loss in order to reduce your taxes, And now, because everyone who went away for the holidays didn't come back, your appreciated long calls will be unchanged in January and you will take your gain then? You live in a perfect world, eh?
Methodology of the DITM Vertical Bull Call Spread
- Thread starter yucca_mtn
- Start date
Volatility is a funny animal. It increases when the market drops, not only on the expectation of that drop. If the market expects a drop then it would already be sold off since most trsders are nots going to stay long or buy if a drop is expected. In fact people will short stocks or the market and fulfill the expectation. The point is that if the market truly expects something they act on it, not sit back and buy options on the expectation. Now segments of the market may do this but your assumption is that if the overall market has a directional bias, then my point is that the price will reflect it, not the options.
The stock traders are usually much bigger than the option traders. For example for someone like GOOG I would venture the daily share volume is greater than the daily option volume (too lazy to check this so if I am wrong I apologize). Therefore the expectation of a drop in the price in GOOG would lead to a drop in the price of GOOG, not an increase in the price of puts alone without any move in the stock.
now if the market expects a move but overall the direction is not known (i.e., before an earnings announcement), then both the calls and puts would experience an increase in IV as a move is expected and the uncertainty increases. Once that uncertainty is taken away (i.e., the news is released), the IV tends to decrease. However the stock moves before the option (options are derivatives remember).
So options may contain market expectation only to the extent that the options reflect the expectation of a large move through increased IV. However, options do not really reflect expectation individually. Some say the put/call ratio is a contrarian indicator or market expectation but I doubt it is ever conssitent.
Black-Scholes model prices an option based on expected range of prices of the underlying dependent on volatility and time to expiration (interest rates and dividends are lesser factors). So an option will be priced (either call or put) based on the stocks potential distribution of prices over a specific period of time discounted to present time and does not take into account direction.
The market expectation of price direction is reflected in how the stock is traded. If the market expects goog to move higher, then buyers push the stock higher.
The stock traders are usually much bigger than the option traders. For example for someone like GOOG I would venture the daily share volume is greater than the daily option volume (too lazy to check this so if I am wrong I apologize). Therefore the expectation of a drop in the price in GOOG would lead to a drop in the price of GOOG, not an increase in the price of puts alone without any move in the stock.
now if the market expects a move but overall the direction is not known (i.e., before an earnings announcement), then both the calls and puts would experience an increase in IV as a move is expected and the uncertainty increases. Once that uncertainty is taken away (i.e., the news is released), the IV tends to decrease. However the stock moves before the option (options are derivatives remember).
So options may contain market expectation only to the extent that the options reflect the expectation of a large move through increased IV. However, options do not really reflect expectation individually. Some say the put/call ratio is a contrarian indicator or market expectation but I doubt it is ever conssitent.
Black-Scholes model prices an option based on expected range of prices of the underlying dependent on volatility and time to expiration (interest rates and dividends are lesser factors). So an option will be priced (either call or put) based on the stocks potential distribution of prices over a specific period of time discounted to present time and does not take into account direction.
The market expectation of price direction is reflected in how the stock is traded. If the market expects goog to move higher, then buyers push the stock higher.
Good synopsis.
Well the market is allowing me to continue my vacation today.
I like the rare spells, makes me a little nervous too.
Here is an average guy. He has some money saved up, but not enough to turn over to a professional money manager with a proven tract record. His doesnât not trust his stock broker to handle his life savings. He thinks that his retirement years may be a little lean unless he generates more income. He wants an investment strategy. Say he has a target in mind to earn an extra $1000 a month, beyond what his fixed income can generate. This extra money is not to pay the bills, but to improve his lifestyle.
So he wants an investment strategy.
a. Go to Vegas and keep doubling down on black.
b. By stocks and watch them go up and down.
c. Junk bonds
d. Stock Options
He chooses options. Now to select a strategy.
Here is a strategy where you win big when the stock skyrockets, but you lose if it doesnât.
Here is a strategy where you win big if the stock moves a lot in either direction, but you lose if it doesnât.
Hear is a strategy where you win if the market goes up, and you win if the market stays the same, and you may win if the market even drops a little.
I choose that last one, itâs called DITM Vertical Bull Spread. So what do I have to know to use it properl? I donât mind a little work if it leads to a better financial future, but I'm not going back to college!
What are the personel traits required to accomplish his goal?
He needs will, perseverance, and desire to accomplish his goal. This is not the kind of perseverance needed to climb Everest, just the kind you need to start any new job or hobby that you want success in, and to learn the required skills.
Here are the skills and knowledge that I think this guy needs to trade spreads successufully:
1. Learn basic computer skills, plus fast internet connection
2. Learn the basics of options, and spreads and the terminology associated with that stuff. Learn the language.
3. Learn the basic ideas behind the strategy of the DITM Vert bull spread, how it behaves as the price of the underlying stock moves, when the spread is successful, when it is in trouble.
4. Learn about expiration issues, execution issues, assignment issues.
5. Learn how to select prospective stocks. Learn the basics of fundamental evaluation of a stock. Learn how to find and use informational sources that you trust. Learn how to look at a chart, learn about moving averages, and RSI and some accumulation/distribution indicator. It is not necessary to become expert in the indicators, but looking at a chart and gathering pertinent information from it is a required skill.
6. Learn how to select sectors that are expected to show strength during the interval of your spreads.
7. Learn how to cull the stock picks for spread candidates. Learn how to select the calls (or puts) that satisfy your risk requirements.
8. Learn about diversification
9. Learn about money management, bookkeeping, position analysis factors.
10. Learn what to do when the price movement of the stock affects your spread position. Learn the decision making process to assess the situation unemotionally, and make proper decisions that will benefit your risk/reward picture. There are many choices available to you ranging from the ridiculous to the brilliant.
These issues are not, in my opinion beyond the scope of the average person to understand.
So this thread can end with the very next post. Just tell me (and any other interested parties) where a single source of information is that covers all this information, specifically related to DITM vertical spreads, and that the average person can read and understand.
I looked very hard for this information and gathered what I learned from many sources, some of which were flat out misleading. Some of them lied. Please share if you know of accredited sources to satisfy these specific topics.
I like the rare spells, makes me a little nervous too.
Here is an average guy. He has some money saved up, but not enough to turn over to a professional money manager with a proven tract record. His doesnât not trust his stock broker to handle his life savings. He thinks that his retirement years may be a little lean unless he generates more income. He wants an investment strategy. Say he has a target in mind to earn an extra $1000 a month, beyond what his fixed income can generate. This extra money is not to pay the bills, but to improve his lifestyle.
So he wants an investment strategy.
a. Go to Vegas and keep doubling down on black.
b. By stocks and watch them go up and down.
c. Junk bonds
d. Stock Options
He chooses options. Now to select a strategy.
Here is a strategy where you win big when the stock skyrockets, but you lose if it doesnât.
Here is a strategy where you win big if the stock moves a lot in either direction, but you lose if it doesnât.
Hear is a strategy where you win if the market goes up, and you win if the market stays the same, and you may win if the market even drops a little.
I choose that last one, itâs called DITM Vertical Bull Spread. So what do I have to know to use it properl? I donât mind a little work if it leads to a better financial future, but I'm not going back to college!
What are the personel traits required to accomplish his goal?
He needs will, perseverance, and desire to accomplish his goal. This is not the kind of perseverance needed to climb Everest, just the kind you need to start any new job or hobby that you want success in, and to learn the required skills.
Here are the skills and knowledge that I think this guy needs to trade spreads successufully:
1. Learn basic computer skills, plus fast internet connection
2. Learn the basics of options, and spreads and the terminology associated with that stuff. Learn the language.
3. Learn the basic ideas behind the strategy of the DITM Vert bull spread, how it behaves as the price of the underlying stock moves, when the spread is successful, when it is in trouble.
4. Learn about expiration issues, execution issues, assignment issues.
5. Learn how to select prospective stocks. Learn the basics of fundamental evaluation of a stock. Learn how to find and use informational sources that you trust. Learn how to look at a chart, learn about moving averages, and RSI and some accumulation/distribution indicator. It is not necessary to become expert in the indicators, but looking at a chart and gathering pertinent information from it is a required skill.
6. Learn how to select sectors that are expected to show strength during the interval of your spreads.
7. Learn how to cull the stock picks for spread candidates. Learn how to select the calls (or puts) that satisfy your risk requirements.
8. Learn about diversification
9. Learn about money management, bookkeeping, position analysis factors.
10. Learn what to do when the price movement of the stock affects your spread position. Learn the decision making process to assess the situation unemotionally, and make proper decisions that will benefit your risk/reward picture. There are many choices available to you ranging from the ridiculous to the brilliant.
These issues are not, in my opinion beyond the scope of the average person to understand.
So this thread can end with the very next post. Just tell me (and any other interested parties) where a single source of information is that covers all this information, specifically related to DITM vertical spreads, and that the average person can read and understand.
I looked very hard for this information and gathered what I learned from many sources, some of which were flat out misleading. Some of them lied. Please share if you know of accredited sources to satisfy these specific topics.
Not to take anything away from your post, but I thought this an interesting comment. So far today, 2.2M shares of GOOG traded, about 22,000 option contracts, so, in terms of total shares controlled, they're actually MUCH closer than I expected!
And you recommended a highly speculative strategy? I think you'd fail Investment Advisor 101 on this one.
Your average guy should be looking to options if he has the money to lose, not to help him make it to retirement.
To your average guy, allocate his portfolio appropriately to his age. If he's near retirement, he'd better be mostly in fixed income, if he's got a ways to go, he'd better be mostly in stocks.
There are some excellent mutual funds out there which don't require large capitalization to sign up for. There are some interesting ETFs if you want to play sectors.
My retirement money is happily locked up in a variety of funds and bonds. My speculation money is being put into futures and options. There's a huge difference--one I can afford to lose, the other I can not.
Interesting... I wonder if it will finish the day with those values lol.
I guess my point was that a market perception that GOOG will move lower results in shorts and buyers sitting on the sidelines and the stock price dropping. The options react to the change in the price of the stock. Thus market sentiment is reflected mainly in the stock pricing and not in the option pricing.
I guess my point was that a market perception that GOOG will move lower results in shorts and buyers sitting on the sidelines and the stock price dropping. The options react to the change in the price of the stock. Thus market sentiment is reflected mainly in the stock pricing and not in the option pricing.
Do you think then that there might be some imbalances in the world of options from bull or bear outlooks?
All things being equal as to equal expectation of a bear market or
a bull market, and factual fundamental information about a company, and identical characteristics as to OTM/ITM, do you think a bull options spread has identical yield/risk/reward as a bear options spread? Is the options world biased towards either type of outlook?
Honestly, on its own, the delta of the option is the best back of the envelope estimate of the probability of the option expiring ITM. A spread has a delta as well. If the stock is right at $40 then a $40/$35 bear put spread and a $40/$45 bull call spread should have the same value theoretically. However, Iv is never constant across strikes so one will be worth more than the other and liquidity in certain strikes might cause one to have a slightly wider b/a spread.
The imbalances come from volatility skews and liquidity issues and the fact that the stock is never exactly right on a round figure price. There are also imbalances such as people selling calls for covered calls and others buying puts for insurance which enhances the IV skew.
Now if there is fear in the market, more puts might be purchased and the put/call ratio could be very bearish but some view this as bullish from a contrarian point of view, so who is right?
So many factors go into distorting option prices it is very hard to generalize productively.
The imbalances come from volatility skews and liquidity issues and the fact that the stock is never exactly right on a round figure price. There are also imbalances such as people selling calls for covered calls and others buying puts for insurance which enhances the IV skew.
Now if there is fear in the market, more puts might be purchased and the put/call ratio could be very bearish but some view this as bullish from a contrarian point of view, so who is right?
So many factors go into distorting option prices it is very hard to generalize productively.