Question: Calendar but DITM

T

thinkplus

Can someone help me understand the R/R on this one?

Here is a scenario:

Say Index is @200 in Dec. 07

Buy 1 Jun08 call @150 for 54
Buy 1 Jun 08 Put @250 for 50

Sell 1 Jan 08 215 Call @1.50
Sell 1 Put 08 185 Put @3.00

If the index remains between 215/185, written ones expire, and I repeat the write for the next month.

I know this will tie up a lot of capital, but I think this a less risky way. I am trying to generate only 4-5% with less risk.

What should I consider? Is there a better way?

Thnx
 
Quote from thinkplus:

Buy 1 Jun08 call @150 for 54
Buy 1 Jun 08 Put @250 for 50
More...

For starters, you could have an equivalent position and save yourself 100 points by buying the 150 put and the 250 call instead.

Sell 1 Jan 08 215 Call @1.50
Sell 1 Put 08 185 Put @3.00

If the index remains between 215/185, written ones expire, and I repeat the write for the next month.

I know this will tie up a lot of capital, but I think this a less risky way.
More...

Those short options are where your risk is. Not the long ones. You're writing strangles and if the index strays outside your 185-215 range you will still lose money. Granted, you'll stop losing money at 150 or at 250, but that's not really a meaningful level of protection.

What is your goal with the 150/250 legs?
 
Quote from commiebat:

What is your goal with the 150/250 legs?
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the only reasoning is that DITM will have more intrinsic value, so overall the time value lost will be minimal.
 
Quote from thinkplus:

the only reasoning is that DITM will have more intrinsic value, so overall the time value lost will be minimal.
More...

Actually, the time value is exactly the same. An OTM strangle is synthetically equivalent to an ITM strangle. The only difference is that the ITM one requires more capital due to intrinsic value. The % of tied up capital lost in time value is small, but the absolute amount is exactly the same.
 
Quote from thinkplus:

the only reasoning is that DITM will have more intrinsic value, so overall the time value lost will be minimal.
More...

Sure, the time value lost will be minimal, but all that intrinsic value is potential loss. Your supposed protection is so far out of the money that it's no protection at all. Your maximum loss is 35 points in either direction, which is effectively an unhedged position.

It's worth paying a little time value to set a reasonably near-the-money price at which you stop losing intrinsic value. That's what hedging is all about.
 
I must add that the orignal plan was to write calendar spreads or covered calls against leaps with DITM calls. Then a put side was added for the same type of trade.

It looks like either I will end up with a strangle, and then DITM options may not help, or I may end up with the credit spreads/iron condor.

I read that looking for a low return (and high probability) may get killed by one bad trade. of ourse, there is no free lunch, but is there a better way than credit spreads or CCs to expect 5% per month?
 
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