Naked or spread

[Kim Klaiman]

There is always a tradeoff.

Going with lower deltas (far OTM) = less credit, less potential gain but also less adjustments.
Higher deltas = more credit, more adjustments.

Finding the right balance is a personal choice, based on risk tolerance, willingness to "babysit" the position more etc.

To me, the main disadvantage of very low deltas (like 4-6) is the fact that you cannot close it early, you usually will need to hold till expiration. Since the initial credit is already low, closing early doesn't leave you with much profit.

Going with 25-30 deltas means most likely you will need to adjust each trade, maybe more than once.

To me, 12-15 deltas provides the best balance. It is still high probability, relatively decent credit, and option to close early while still getting decent gain. But again, it is a personal decision, there is no really right or wrong here. The most important thing is to limit the losses, no matter which setup you select.

 

[sle]

The trick with a short option (naked) is getting the direction right and that does not change just because you added a long leg for crash protection (vertical).

If anything, you have to be "more right" on the spread than on a naked option. At the limit, a spread becomes a digital bet, i.e. if you trade a very tight call or put spread, you will have almost not exposure to volatility (as would be evidenced by negligible gamma and Vega). On the other hand, with a naked option (outright or delta-hedged, no real difference) you can easily be wrong on price but still make money by being right on volatility.

 

[spindr0]

I've certainly seen plenty of discussion by seemingly "good" traders who prefer to trader closer to the money, even with spreads, and they accept the fact that they'll have to adjust more often. I don't know if it's human nature at work for everyone but my own nature tends to make me averse to adjusting, and I get into "hope" mode when things start to go south. At that point things usually go further south.

True but sometimes lightning strikes. Two years ago I was short EXPE pre earnings at $88 with a $86p / $89c collar. EXPE crashed and since I hoped for further volatility, I covered the short shares at $78 and I bought $78 puts in maybe a 1.3 ratio (13 long puts per 1,000 shares). A big move in either direction would win though flattening out would result in dying on the vine from time decay.

I got early assignment on the short $86 puts (8 pts ITM) and a week later, they announced the buyout of Orbitz. I sold my EXPE shares at $87+, salvaged 1/4 of the long call premium and was happy to have thrown away the money on the $78 long puts. Sometimes the "hope" mode works after things go south, though rarely as nicely as this one.

 

[spindr0]

If anything, you have to be "more right" on the spread than on a naked option.... On the other hand, with a naked option (outright or delta-hedged, no real difference) you can easily be wrong on price but still make money by being right on volatility.

While that may be true, I'll take having to be "more right" with the spread than ending up far "more wrong" with the naked option.

As for volatility exposure, on my level, unless it's a volatility play on earnings, volatility exposure doesn't mean much since it tends to even out over time. Other than EA's, I'm not clever enough to know where volatility is going (I KNOW that vols are going down after the EA :->)

 

[jimmyjazz]

My biggest beef with spreads versus individual options (long or short) is the added commissions and fees to get to a given level of potential profit. This is countered somewhat by better fills, especially when I was on optionsXpress with their "Walk" feature. (I doubt that's anything truly revolutionary, but I could at least see it in action and it gave comfort.)

Of course, one can deal in wider spreads, but that starts heading down the continuum towards individual options.

 

[sle]

While that may be true, I'll take having to be "more right" with the spread than ending up far "more wrong" with the naked option.

As for volatility exposure, on my level, unless it's a volatility play on earnings, volatility exposure doesn't mean much since it tends to even out over time. Other than EA's, I'm not clever enough to know where volatility is going (I KNOW that vols are going down after the EA :->)

I am just saying that trading a spread and trading naked options are somewhat different skills. If you have a good call on price, trading spreads makes more sense (assuming you can overcome the additional transaction costs). If you are trading volatility, it makes more sense to trade naked options (and maybe buy back the wings to avoid extreme losses).

 

[spindr0]

I don't think much about commissions with spreads since at 70 cents per contract, it's peanuts given the profit potential. What cuts into the meat is the add'l B/A spread, even more so when options go deeper ITM.