option strategy question #2!

C

crayon851

sle gave me this idea, but I assume its already been done and picked apart. Wasn't sure what to search to id this or what this strat is called, but what if you make a pseudo IC

for example: make use of stop limit orders on the underlying

Stock abc currently trading at $5.

Sell OTM 3.00 put for 0.25
Sell OTM 7.00 Call for 0.25

Place STOP limit order to short at $2.99
Place STOP limit order to buy shares at $7.01.

Wait till expiration and you collect the premium for $49.

Scenario 1) before expiration abc is all over the place and drops to 2.99, you short position is taken before expiration.

You are now short the stock. If the stock continues to drop, you profit on the downside from the underlying and can use the proceeds to close your short put. Or just hold it till expiration and use the proceeds to buy the stock for 3.00 netting you $49. Or if it drops , hits your stp order and then goes back up I guess you can put another order to buy back the shares.

Scenario 2) Before expiration abc is all over the place and jumps to 7.01 and your long position is executed before expiration.

You are now long the stock and like scenario 1 you can use the upside to close your short position or profit on it or wait till expiration. Same set up as scenario 1 just with buying.

Is there any thing you guys see that can wrong with this strategy? In my mind, it seems like a solid win or break even, assuming you can buy/short the shares.
 
crayon851 said:
Is there any thing you guys see that can wrong with this strategy?
More...

what happens after scenario 1) or 2).....?
You have to deal with scenario 1)a), or 2)a) ....or worse --- 1) then 2)

You should learn about the relationship between puts and calls and the underlying.

This way you might understand that by hedging the put or the call, you are in fact turning your risk profile into a call or a put.
You are not eliminating the risk, you are merely changing your risk profile.
 
SIUYA said:
what happens after scenario 1) or 2).....?
You have to deal with scenario 1)a), or 2)a) ....or worse --- 1) then 2)

You should learn about the relationship between puts and calls and the underlying.

This way you might understand that by hedging the put or the call, you are in fact turning your risk profile into a call or a put.
You are not eliminating the risk, you are merely changing your risk profile.
More...

As a general rule, there are no guarantees in trading. So if you have found the holy grail, you should look for the problem areas.

One thought for you is, what happens with your strategy if earnings are announced and there is a "gap" before your options market opens. Could you hedge the underlying in a different market?

Another thought for you is: if is is so easy to do, then why isn't everyone doing it?

A stock is actually an option, or perhaps more accurately a warrant. Options buy and sell risk, but ultimately risk happens!
 
Your hedge execution makes sense on paper. How do you pre-screen your candidates ( if its not a secret ) ? Does volatility come into play? I hope it does.

In practice, you will have to contend with a lot of factors,, slippage, transaction costs, appropriate time frame Sounds like your day trading or doing weeklies stop loss/take profit psychology.

Go ahead make a lot of small trades, track your profitability on a journal, then see if your strategy works on a risk adjusted basis.

In option trading, a winning long term strategy should have a portfolio PL with less volatility than your benchmark. Unfortunately, I don't know what my appropriate benchmark is :p
 
Crayon.

Never be afraid to ask questions (even if people laugh at your questions), since we all learn by asking questions and we were all once (upon a time) beginners. In fact, one of the ways to be an expert is to refine one's questions until one discovers the best questions to ask and answer. I make mistakes every year and learn from them until I make fewer mistakes and make more money.

My problem is that I will not reveal some of those best questions on this site to certain individuals. One edge can be to have the best understanding of the finer points of things than most. After all, isn't this what a university does every day? (Here is what we know and this area is what we are uncertain about. One has to know what the area of known is precisely before one can play in the creative sandbox to build a new castle.)
 
sle said:
This "strategy" is a classic interview question for option traders. The answer is, obviously, that it does not work, but I'll let you guys come up with the reason why.
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Surely this is a bit too easy to be an interview question... In fact, how can it even be a question?
 
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