--> Options to limit equity exposure (Swing Trading)

[short&naked]

I am looking for the most conservative option strategy that will allow me to swing trade equities without having full exposure.

The problem with traditional money management is that stop are tough to implement in a market that can have huge overnight gaps.

Is there such a strategy that allows you to limit exposure to equities and does not kill a trade with theta burn and expiration? (Or am I asking for something that isn't possible according to the risk/reward model?)

Are LEAPS the answer?

Thank you for your time!

 

[heech]

Yea, I've considered a strategy along those lines... sort of the inverse of a delta-hedge?

For example, let's say:

- I buy a straddle at strike price 20 (let's say). 10 calls, 10 puts.

- If stock goes up to 21, I short 500 shares. I have nothing to "lose" from the short position... it's protected by the call. I've already locked in $500. If stock keeps going up, the straddle itself will be profitable.

- If stock now dips down to 20, I can close out the short. And I can wait for the next swing away from 20 to do the same thing again.

- Same for the downside. If price dips to 19, I buy 500 shares. If price keeps dipping, my straddle itself will be profitable. If price goes back up, the straddle will lose money... but I can profit from the swing trade.

Seems like it'd be a lot more fun than "traditional" swing trading. Price going against me? No problem, the option leg is doing well. Price going in my direction? Great.

PS. When I say "considered".. I meant I've done some great potty-bowl pondering. I'd love some insight as to why the above might not work.

 

[gody3]

LEAPS are not the answer because they tend to have larger spreads and cost too much more. You want cheapest protection for the shortest period of time that is more then your swing trade period.

 

[MTE]

Quote from heech:

Yea, I've considered a strategy along those lines... sort of the inverse of a delta-hedge?

For example, let's say:

- I buy a straddle at strike price 20 (let's say). 10 calls, 10 puts.

- If stock goes up to 21, I short 500 shares. I have nothing to "lose" from the short position... it's protected by the call. I've already locked in $500. If stock keeps going up, the straddle itself will be profitable.

- If stock now dips down to 20, I can close out the short. And I can wait for the next swing away from 20 to do the same thing again.

- Same for the downside. If price dips to 19, I buy 500 shares. If price keeps dipping, my straddle itself will be profitable. If price goes back up, the straddle will lose money... but I can profit from the swing trade.

Seems like it'd be a lot more fun than "traditional" swing trading. Price going against me? No problem, the option leg is doing well. Price going in my direction? Great.

PS. When I say "considered".. I meant I've done some great potty-bowl pondering. I'd love some insight as to why the above might not work.

Sure it works, it's called gamma scalping, use the search button above to find threads discussing this, also you can google it.

The trick is to define the adjustment points correctly, i.e. when are you going to buy/sell the shares against your straddle.

 

[spindr0]

>> I am looking for the most conservative option strategy that will allow me to swing trade equities without having full exposure. The problem with traditional money management is that stop are tough to implement in a market that can have huge overnight gaps. >>

There's no cut and dried answer because there are a lot of variables involved, not only on the option side (time, strike, IV, strategy) but on the equity side as well (swing trade length, avg gain per trade) as well as the net of both (risk/reward).

The first question that comes to mind is what do you mean by conservative? Low in cost? High in protection? It's A or B, not both


>> Is there such a strategy that allows you to limit exposure to equities and does not kill a trade with theta burn and expiration? Or am I asking for something that isn't possible according to the risk/reward model? Are LEAPS the answer? >>

"Are LEAPS the answer?" suggests that you're considering long puts. If so, the first consideration is cost vs protection. If you want maximum protection, you buy ATM and pay top dollar. If you can tolerate some downside, you go down a strike and pay less for your insurance but risk more underlying loss.

If you're dealing with ATM LEAPS, they will tend to hold up better than short term if the underlying rises (salvage value) and more so at lower IV. If you're dealing with OTM LEAPS, they will not tend to hold as well as near months. Check the respective deltas and you'll see why.

Other possibilities include bearish put spreads below which will cost less than outright long puts but will not help much with "huge overnight gaps", over written calls or bearish call spreads above, and the collar. Lots of possibilities and lots of variations all of whose selection will have a lot to do with the volatility of the underlying as well as your success to the upside (size and frequency of gains).

I would tend to lean toward trading clean and being green by the end of the session. If your set ups run longer (days) then I'd lean toward collaring the position near the end of the day in ordr to diminish the cost of the protection... as long as you're willing to achieve a profit with an AM gap up but a limited one.

Another possibility is pairs (which I do) but in order for that to work, you have to figure out how to correlate the underlyings.


Oh and don't forget, you can trade any component of a hedged position intraday (preferably the underlying) and restore it by the end of the day.

 

[spindr0]

Quote from heech:

[When I say "considered".. I meant I've done some great potty-bowl pondering. I'd love some insight as to why the above might not work.

If you don't lock in the cost of your straddle and the underlying range trades, you're faced with double side time decay. W/O money management, that will eventually turn the position into a loser. The other consideration is IV contraction.

In order for your strategy to work you need some combination of timing, price movement and IV maintenance. If the underlying cooperates, it's a field day. If not, it's a time decay grinder.

 

[heech]

Quote from MTE:

Sure it works, it's called gamma scalping, use the search button above to find threads discussing this, also you can google it.

The trick is to define the adjustment points correctly, i.e. when are you going to buy/sell the shares against your straddle.

Great, thanks for the pointer!

 

[dmo]

Quote from MTE:

Sure it works, it's called gamma scalping, use the search button above to find threads discussing this, also you can google it.

The trick is to define the adjustment points correctly, i.e. when are you going to buy/sell the shares against your straddle.

Here's an article on the subject: http://www.elitetrader.com/vb/attachment.php?s=&postid=2013852

 

[heech]

Quote from dmo:

Here's an article on the subject: http://www.elitetrader.com/vb/attachment.php?s=&postid=2013852

This is really fascinating stuff.

I'm trading an automated strategy I developed, which is in essence short options delta-hedge... it loves theta and hates gamma. I screen a universe of stocks for choices that fit my criteria, and then trade them... and hope the numbers work out.

Well, now that I've edumacated myself with gamma scalping... I can do what the long/short hedge funds do (with equities)... take the universe of stocks that I screen, take the "worst" stocks, and just invert them... go long option, hate theta, and love gamma.

Should be a great way to get rid of some of the volatility I have in my results, and shouldn't affect results!