Naked Option versus a Spread

E

EliteTraderNYC

Lets say hypothetically, you have a system which produces wins 70-80% of the time averaging say, gains of 10% and losses of 2%, average holding time is 7 to 10 days but could be as long as 15 days. Can choose front month or second month out.

Would you choose a naked option or a spread and why?

Advantage of naked option:
can be larger gains on big moves
benefits from increasing vol
only 1 side hits on the bid/ask spread and slippage

Disadvantage of naked option:
time melt will kill premium
victim of decreasing vol

Advantages of spread:
less susceptible to a vol crush
less susceptible to time decay

Disadvantages of spread:
you take a double hit on slippage and bid/ask spread
there are lower gains than a naked call/put in the case of a large move.
 
I hope you have not sold any naked puts or credit spreads yet, because you really do not understand how they work yet.
Or are you refering to something other than naked puts and spreads?
If so, sorry I misunderstood, but I only did a quick read, as I'm on my way out.
 
Quote from EliteTraderNYC:

Lets say hypothetically, you have a system which produces wins 70-80% of the time averaging say, gains of 10% and losses of 2%, average holding time is 7 to 10 days but could be as long as 15 days. Can choose front month or second month out.

Would you choose a naked option or a spread and why?

Advantage of naked option:
can be larger gains on big moves
benefits from increasing vol
only 1 side hits on the bid/ask spread and slippage

Disadvantage of naked option:
time melt will kill premium
victim of decreasing vol

Advantages of spread:
less susceptible to a vol crush
less susceptible to time decay

Disadvantages of spread:
you take a double hit on slippage and bid/ask spread
there are lower gains than a naked call/put in the case of a large move.
More...

2% of a 5.00 premium is a dime. The spread is likely larger than your stop. I don't see trading singles or spreads as feasible for a system that has such tight stops.
 
Quote from EliteTraderNYC:

Lets say hypothetically, you have a system which produces wins 70-80% of the time averaging say, gains of 10% and losses of 2%, average holding time is 7 to 10 days but could be as long as 15 days. Can choose front month or second month out.

Would you choose a naked option or a spread and why?

Advantage of naked option:
can be larger gains on big moves
benefits from increasing vol
only 1 side hits on the bid/ask spread and slippage

Disadvantage of naked option:
time melt will kill premium
victim of decreasing vol

Advantages of spread:
less susceptible to a vol crush
less susceptible to time decay

Disadvantages of spread:
you take a double hit on slippage and bid/ask spread
there are lower gains than a naked call/put in the case of a large move.
More...

Not enough info. First off, strictly speaking, you cannot be naked long an option. 'Naked' specifically means that you wrote a contract and don't own the underlying to offset it. You seem to be referring to "outright buys". IOW, buying an option without an offsetting position.

We have to assume that you are referring to 70-80% success in forecasting direction. Neither spreads nor naked buys are either superior or inferior. Trading options isn't about delta. Trading options is about delta, theta, vega, and gamma.

Buying outrights on a delta forecast with no regard for the other greeks is asking for trouble. If you only care to forecast direction, then either trade the underlying ticker, or construct options spreads that are more or less vega and/or theta neutral.

There is no way to be vega/theta neutral with outrights. So the answer to your question depends on your vol outlook. You should really only be buying outrights if your vol forecast is >= current IV. If your vol forecast is < current IV, then there are spreads that would better profit from your accuracy on both direction and vol.
 
Quote from Epic:

Not enough info. First off, strictly speaking, you cannot be naked long an option. 'Naked' specifically means that you wrote a contract and don't own the underlying to offset it. You seem to be referring to "outright buys". IOW, buying an option without an offsetting position.

We have to assume that you are referring to 70-80% success in forecasting direction. Neither spreads nor naked buys are either superior or inferior. Trading options isn't about delta. Trading options is about delta, theta, vega, and gamma.

Buying outrights on a delta forecast with no regard for the other greeks is asking for trouble. If you only care to forecast direction, then either trade the underlying ticker, or construct options spreads that are more or less vega and/or theta neutral.

There is no way to be vega/theta neutral with outrights. So the answer to your question depends on your vol outlook. You should really only be buying outrights if your vol forecast is >= current IV. If your vol forecast is < current IV, then there are spreads that would better profit from your accuracy on both direction and vol.
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yeah... thats a good post! +1... leverage options on delta bets means you are implicitly speculating on the other risks associated with the purchase of those options.. as stated mostly vega and theta... gamma is just a second order to delta.. with options you have an explicit time stop being expiration... and typically the "stop" on the trade is the full premium paid on the option unless you are managing the trade .. count on any stops getting filled anywhere near the price action... one example of a good bet considering TA.. is a compression triangle breakout... if your looking for continuation up.. buying a call you will be buying one side of the distro.. you'll be in a werid way long vol.. and long delta... reason why i say werid way.. because there is a direct link between long vol as short equities..

the biggest downfall of putting on spreads is you lose convexity at higher levels... spreads still lose when implieds decrease all else being equal.. you have to be right about direction, timing, and the more you are right about those things the decreasing value your vol/theta speculations become.. it goes from daytrading options at expiration , to swing trading spreads near expiration.. with flys you can leverage theta in your favor if you good at delta bets..
 
Quote from cdcaveman:

yeah... thats a good post! +1... leverage options on delta bets means you are implicitly speculating on the other risks associated with the purchase of those options.. as stated mostly vega and theta... gamma is just a second order to delta.. with options you have an explicit time stop being expiration... and typically the "stop" on the trade is the full premium paid on the option unless you are managing the trade .. count on any stops getting filled anywhere near the price action... one example of a good bet considering TA.. is a compression triangle breakout... if your looking for continuation up.. buying a call you will be buying one side of the distro.. you'll be in a werid way long vol.. and long delta... reason why i say werid way.. because there is a direct link between long vol as short equities..

the biggest downfall of putting on spreads is you lose convexity at higher levels... spreads still lose when implieds decrease all else being equal.. you have to be right about direction, timing, and the more you are right about those things the decreasing value your vol/theta speculations become.. it goes from daytrading options at expiration , to swing trading spreads near expiration.. with flys you can leverage theta in your favor if you good at delta bets..
More...

Not sure I follow your argument that "spreads still lose when implieds decrease all else being equal." Why is it naturally assumed that spreads would be positioned at the higher levels where they lack convexity? The driver behind using a spread is to either profit from errant convexity, or simply remove it from the equation. Also, we've said nothing about what type of spreads. I would argue that it might be easier for a good vol trader to generate alpha than a good directional trader.

My basis for that claim is that my research suggests that there are more frequent pricing anomalies available to the retail trader in vol than there are in direction. Pricing anomalies arising from abnormal order flow aren't as frequent nor as dramatic in the underlying as they are in the options. Imagine a CFO selling calls against a substantial equity holding in the company. He does so with pretty much zero regard to whether the IV is high or low. He has no direct volatility motive. Also imagine a company prepping for stock buyback by selling puts. If large enough, these orders create inefficient options pricing, but the same isn't true of the underlying. In fact, absent new info, the market value of the underlying hasn't changed at all.

But I agree that if directional trading is his thing, then don't try to profit from vega. Just be aware of it and structure the trade so as to eliminate vega or at least not work against it.
 
Quote from Epic:

Not sure I follow your argument that "spreads still lose when implieds decrease all else being equal." Why is it naturally assumed that spreads would be positioned at the higher levels where they lack convexity? The driver behind using a spread is to either profit from errant convexity, or simply remove it from the equation. Also, we've said nothing about what type of spreads. I would argue that it might be easier for a good vol trader to generate alpha than a good directional trader.

My basis for that claim is that my research suggests that there are more frequent pricing anomalies available to the retail trader in vol than there are in direction. Pricing anomalies arising from abnormal order flow aren't as frequent nor as dramatic in the underlying as they are in the options. Imagine a CFO selling calls against a substantial equity holding in the company. He does so with pretty much zero regard to whether the IV is high or low. He has no direct volatility motive. Also imagine a company prepping for stock buyback by selling puts. If large enough, these orders create inefficient options pricing, but the same isn't true of the underlying. In fact, absent new info, the market value of the underlying hasn't changed at all.

But I agree that if directional trading is his thing, then don't try to profit from vega. Just be aware of it and structure the trade so as to eliminate vega or at least not work against it.
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i lost myself, myself.. hhaha if skew flattens out along with vol.. your screwed if your long a put spread.... but generally your screwed direction wise to respectively..
 
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