Question for Mav

[mbradley]

Mav, since you have such good knowledge of options and a great way of explaining, I would like to put to you the following question.


Suppose I am looking at a pure direction bet. Let us say my method is to stalk a storng stock in a strong sector like Darvas or O'Niel and buy it at the pivot. So I am expecting some immediate follow through or I would be cutting.

What would be your favorite way of playing this. Of course, you could just buy stock, but assuming you wanted to have your capital in several different areas, we are using options. Would you:

1) Keep it simple and just buy calls. If so, would you rather play it with say, a 5 lot in the money, 10 lots ATM or 20 lots OTM

2) Calendar Spread. I know you do not like the long calendar spread. But for a directional bet, do you see an advantage of "renting the front month" to help pay for the back month. Would your short calendars be and advantage

3) Ratio Spread. Sell 1 ATM and Buy 2 OTM, etc.


I would love to see your thoughts on the best way to play a pure directional bet. Using your creativity, Im sure there is something in your noodle that takes advantage of the direction while minimizing volatility imploding, time decay and gamma risk.

Thanks in advance.

Mike

 

[tikipoki]

Quote from mbradley:

Mav, since you have such good knowledge of options and a great way of explaining, I would like to put to you the following question.


Suppose I am looking at a pure direction bet. Let us say my method is to stalk a storng stock in a strong sector like Darvas or O'Niel and buy it at the pivot. So I am expecting some immediate follow through or I would be cutting.

What would be your favorite way of playing this. Of course, you could just buy stock, but assuming you wanted to have your capital in several different areas, we are using options. Would you:

1) Keep it simple and just buy calls. If so, would you rather play it with say, a 5 lot in the money, 10 lots ATM or 20 lots OTM

2) Calendar Spread. I know you do not like the long calendar spread. But for a directional bet, do you see an advantage of "renting the front month" to help pay for the back month. Would your short calendars be and advantage

3) Ratio Spread. Sell 1 ATM and Buy 2 OTM, etc.


I would love to see your thoughts on the best way to play a pure directional bet. Using your creativity, Im sure there is something in your noodle that takes advantage of the direction while minimizing volatility imploding, time decay and gamma risk.

Thanks in advance.

Mike

If you are looking for direct action, go long the synthetic stock; buy calls & sell puts. What I understand is that the only reason you want to use options is to have more leverage/synthetic buying power, so there you have it.

As for me i'd at LEAST put a more otm put under my position to limit crazy shit and maybe buy far OTM call tails, for a litle something something extra if it REALLY rams through for the price of a hamburger or 2.

For example lets take Unilever, quoted at the FTA for 51.75 (UN), if it was your thought it is going to break out NOW, you could take a position like:

Long C Mar 04 52.00 @ 1.50
Short P Mar 04 52.00 @ 1.70
Long P Mar 04 48.00 @ 0.50
Long C Mar 04 56.00 @ 0.30

Total cost per position = 60 cents, at expiration you have profits over 52.60, heavier profits over 56 (when the move goes through), and your total risk is limited to 52-48+0.60 = 4.60

Time decay, well it is a bitch but 3 months for 60 cents is a fair deal, if the stock breaks out your vol value on the 52 call will decline but so will the value on the short put, plus the 56 call is coming near. If stock falls down, you want to exit quick, vol will be running out the synth stock, too, and there will be a slight vol increase on your protection put.

Cheers,

Tiki

 

[AAAintheBeltway]

mbradley,

The best pure directional play is to just buy the stock, but you already know that. I would suggest that the next best would be a credit spread, ie, if you are bullish, sell an ATM put and buy an OTM put. If you're looking at the IBD100 type stocks, many do not have liquid options and you might be facing some wide spreads. Therefore, you definitely want to avoid strategies that require more than two legs.

The credit spread is not a home run trade. It is a defined risk/defined reward situation.

 

[Maverick74]

Quote from mbradley:

Mav, since you have such good knowledge of options and a great way of explaining, I would like to put to you the following question.


Suppose I am looking at a pure direction bet. Let us say my method is to stalk a storng stock in a strong sector like Darvas or O'Niel and buy it at the pivot. So I am expecting some immediate follow through or I would be cutting.

What would be your favorite way of playing this. Of course, you could just buy stock, but assuming you wanted to have your capital in several different areas, we are using options. Would you:

1) Keep it simple and just buy calls. If so, would you rather play it with say, a 5 lot in the money, 10 lots ATM or 20 lots OTM

2) Calendar Spread. I know you do not like the long calendar spread. But for a directional bet, do you see an advantage of "renting the front month" to help pay for the back month. Would your short calendars be and advantage

3) Ratio Spread. Sell 1 ATM and Buy 2 OTM, etc.


I would love to see your thoughts on the best way to play a pure directional bet. Using your creativity, Im sure there is something in your noodle that takes advantage of the direction while minimizing volatility imploding, time decay and gamma risk.

Thanks in advance.

Mike

Well I dedicated an entire thread to vertical spreads which is what I think you are looking for. And like others have mentioned the credit spread is the one I like the most. If you are right, you save yourself another transaction and can let the options expire worthless. You save the slippage and commission cost.

The synthetics have been mentioned here and that is also a good play. You will get about 5 to 1 margin on your play vs the 2 to 1 margin if you just buy the stock outright in a margin account.

The short calendar works well if your direction you are playing is on the long side since you will have two things working for you. The direction and most likely a drop in vol.

Another option is to buy DITM calls. Depending on your time frame, I would try to buy front month. Buying the DITM option will give you more leverage then just buying the stock and it removes the theta and vega risk. Of course these options are not liquid so you will be paying some slippage but consider that the cost of more buying power.

Back to the credit spreads. If you are really confident in your direction I would go 2 to 4 points ITM the money on the front month credit spread. You risk to reward ratio will be great and you have complete protection from large gap downs in the stock.

 

[mbradley]

Great respsonses, thanks.

Tikipoi, this is very close to what I was originally thinking about. Almost scary. The idea of a synthetic, but with one more put strike to create a spread. In my case, it was for no other reason than to lower the margin. So, on 50.00 XYX

buy the 50 call, sell the 50 put, buy the 45 put.


AAA - IBD 100 type of stocks is exactly what I am looking. Lack of liquidity in those options is something I have thought about, but have not investigated enough. Thanks again for bringing that up.

Mav- my only drawback to the vertical is the caping of the profit potential. These type of trades are diffently things I am entering into for a chance at a runner. DITM straight purchase of multiple units of DITM put credit spreads is certainly viable. In the credit spread case, I think one would have to scale up aggressivly to make up for the lack of upside potential. Thanks.

Best,

Mike

 

[riskarb]

Quote from mbradley:

Great respsonses, thanks.

Tikipoi, this is very close to what I was originally thinking about. Almost scary. The idea of a synthetic, but with one more put strike to create a spread. In my case, it was for no other reason than to lower the margin. So, on 50.00 XYX

buy the 50 call, sell the 50 put, buy the 45 put.


AAA - IBD 100 type of stocks is exactly what I am looking. Lack of liquidity in those options is something I have thought about, but have not investigated enough. Thanks again for bringing that up.

Mav- my only drawback to the vertical is the caping of the profit potential. These type of trades are diffently things I am entering into for a chance at a runner. DITM straight purchase of multiple units of DITM put credit spreads is certainly viable. In the credit spread case, I think one would have to scale up aggressivly to make up for the lack of upside potential. Thanks.

Best,

Mike

There's no advantage to the long synthetic, you'll lose edge in trading it -- preferable to simply go long the underlying shares. The position with the inclusion of the long 45p is called a "married put" and is equiv. to long stock//long 45p. If you were buying the 50p you'd have a synthetic long call struck at 50.

Long time spreads are worthless in a market that moves -- if taking directional bets, avoid a long time spread. Also, short time spreads are a pure volty play, as such, they're not linear w.r.t. return. IOW, they won't look good when the stock is really moving your way. I only add this point as you're concerned with limiting your profit potential(i.e. verticals).

Nothing really fancy about it, you're trading expectation for leverage. Short gamma(long time spread/credit spreads) offer a +expectation but limited returns. Trading the synthetic offers zero value-add over simply going long the spot. There is a regulatory-edge in selling synthetic stock on listed stock, however.

arb.