Quote from Adamoptions:
Thank you all for the fine responses.
My experience in serious trading is 6 months old. I've focused mostly on straddles following McMillian's method and I've had moderate success but I've noticed a few things. First, every straddle that I have played has broken to the side I initially predicted. I don't take this as an indication that I can read the direction of stocks. I see this as a basic flaw in straddles. The price has to swing so far in one direction or another that the price ALWAYS seems to go with the direction of the market trend.
True, in a tight range like what we are experiencing now it's tougher to read that direction and perhaps it's better not to go long at all until a direction is established, but once a trend is in place a well managed strategy of straight plays will probably outperform spreads. Yes, I agree with tinytim on his feelings of spreads.
In straddles or backspreads, when you consider the amount of money you lose until you actually touch a breakeven point plus the amount of time you have to tie up capital (I average 70 days in a straddle), you get the feeling that a straight directional play with tight stops will be more efficient. I don't feel you can use tight stops on options. That's why I think it's better to enter the trade actually buying the underlying and, if a profit shows up, switch to the option and hopefully leverage your gain after the stock has demonstrated some strength. Based on IV, I would decide buying a deep-in-the-money option vs. a vertical spread.
As far as volatility trading goes, implied volatility is probably more predictable then price direction, but I don't see volatility trades being more profitable then price direction. As retail traders, the regular adjustments to keep your trade delta neutral is just too costly. If you don't make regular adjustments the positive gamma will have you playing price very quickly. Yes, you didn't need to pick a direction initially, but you will still have to figure out when to exit the trade based on price. I'm finding that the "buying the privilege" of not having to pick the initial direction is just too expensive, particularly since the direction usually goes with the prevailing trend.
Further, though I very often pick the right direction of IV, often IV doesn't move far enough or fast enough for me to get any real advantage from it. Often the best volatility trades lack liquidity so whatever theoretical edge I start with is usually nullified buy the wider bid/ask spread. Basically, I don't see enough return here to justify the risk. The gains are there, but too small. One big mistake will wipe out most of the gains.
My limited experience has brought me to a strategy that tries to capitalize on the advantages the underlying and the option. I see the underlying with more liquidity, making it easier to keep losses tight and allowing effective use of stop loss orders. The advantage of the option comes from any theoretical edge you can get from IV and leverage. I hope that effectively combining the two at the right times will produce smaller losses and greater gains over spreads. We'll see.
