Options and leverage : Question

[Sammy Iyer]

Hi Smilingsynic

Quote from smilingsynic:

The IV is not high, but deep OTM puts trade at a much higher IV than do ATM puts (negative skew).
To take advantage of the skew I have been known to sell 2 atm puts (or 3 otm) per contract sold (close to delta neutral--a straddle).

Apart from unknown factor of future direction /magnitude of IV (increase/decrease)--
How do you construct Close to Delta Neutral Straddle?
1.Is it by buying long index future/Long stock & sell 2 ATM or 3 OTM puts?(or whatever qty to arrive at Neutral Delta)
2.Sell Stock/future & buy 2 ATM calls /3 OTM calls?
Does Up /down move has a bearing or only the IV factor?
thanks-sammy

 

[murray t turtle]

Quote from Digs:/Option Coach

..."This is a messed up question, are ou just asking which product would give you the most profit on a large drop in price? You are comparing puts on apples and oranges here....20% drop in QQQQ is a lot different than 20% drop in SP."....


Sorry thats the question ? What in order is the best PUT you would buy then ???

================
As a practical matter ,QQQQ is much more likely to move more % up or down than DIA,SPY;
just like apples almost always grow bigger & further north than oranges.

QQQQ can be more liquid getting in;
getting out , not sure any are that liquid, especially options deep OTM priced that ''cheap''.

Also a strike prices you mentioned is much more likely to lose money than ITM or underlying stock.

Digs, can you dig it?????

 

[riskarb]

Quote from uninvited_guest:

Plus a price decline in the underlining, in the case of the puts. I don't think index options really have a rising IV the way stocks do when it comes to expected news. I think I'm on the right track.

Well, they certainly won't retain value into a market rally. Value retention was presumed to be under static-price in the underlying contract.

The strip vols have a rising IV into quaterly reporting season and significant macro news, such as the GDP, Emp#, etc... Certainly it's not nearly as pronounced as in street-volatility.

 

[riskarb]

Quote from Profitaker:

Defining riskiness as a probability of loss, the 2 sigma OTM is more risky. In terms of expectancy (which I think is what you're alluding to) they are both the same.

Right. I will only add that the unhedged position carries much lower greek magnitude with the otm call on a contract-basis.

The delta hedged otm call suffers from convergence losses if implied vols are overstated, which plays into the reduced-expectancy.

I wouldn't necessarily buy hedged otm calls due to the convergence-risk, but if vols are representative, it's not a riskier trade, per se.

 

[riskarb]

Quote from Sammy Iyer:

Hi Risk arb

Quote from riskarb:

OTM index calls have the cheapest gammas. As a rule: buy upside gammas[otm], sell downside gammas[atm].

Which is it better to use? calls / puts to employ this strategy of " selling the ATM & buy the OTM "?
Regards
sammy

The position should parallel your expectation on the shape and slope of the stat-vol distribution. Do you believe there will be a lot of high-vol churn?[long atm/peaky distro] Or do you expect one-way paper will drive vols and prices in one direction?[long otm/wide distro] lepto/platykurtic distribution[kurtosis].

I prefer to be long otm/short atm in terms of position-building, but that has no bearing on trading a single option in isolation.

In answer to your question, it's a draw. In a decline the put skew will diminish due to the contamination of your strike by the vol-smile. Strip vols will rise, but skew will decrease at your strike. Calls don't fare much better into a rally; smile leads an increase in vol at your call strike, but offset by a decrease in strip-vols.

The best-practice method would be a combination-approach, to buy butterflies or condors. atm/otm changes your gamma position.