risk reward opinions?

C

codetroll

Hey,

Note: I don't claim to be an options guru or anything even close, but I find the iron condor, etc. strategies not for me.

Therefore, I like to trade options like stock, basically I look at price action of the underlying security (stock) and make my trade as I would stock (call/put buy). I don't sell, for liabilities purposes, etc. etc.

Just wondering if anyone does this type of trading on a consistent basis and what do you use as a risk/reward for the option?

I usually give myself a gain of: 11%-35% and a loss of around 30-50%. Yeah, not 1:1, but I feel that I should give the stock some wiggle room before I pull the trigger prematurely. UNLESS* it appears to possibly violate a price trend (i.e. major support/resistance). Then I get out as quick as I can.

Any opinions? Just curious.

EDIT:
Forgot to mention I try to buy at least 1 month out expiration and in the money (medium/large delta).
 
Quote from codetroll:

Hey,

Note: I don't claim to be an options guru or anything even close, but I find the iron condor, etc. strategies not for me.

Therefore, I like to trade options like stock, basically I look at price action of the underlying security (stock) and make my trade as I would stock (call/put buy). I don't sell, for liabilities purposes, etc. etc.

Just wondering if anyone does this type of trading on a consistent basis and what do you use as a risk/reward for the option?

I usually give myself a gain of: 11%-35% and a loss of around 30-50%. Yeah, not 1:1, but I feel that I should give the stock some wiggle room before I pull the trigger prematurely. UNLESS* it appears to possibly violate a price trend (i.e. major support/resistance). Then I get out as quick as I can.

Any opinions? Just curious.

EDIT:
Forgot to mention I try to buy at least 1 month out expiration and in the money (medium/large delta).
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You must remember this: If you are skilled at picking stock direction and have a proven track record of making money, then you have a talent shared by few.

But buying options is much more difficult. Not only must the timing be right, but the price of options is influenced by so much more than the stock price.

For example, when the markets rally, the implied volatility of the options tends to decrease. You may pick a winner, but can still lose money buying the options.

It's not impossible, but it's a tough way to make money.

Mark
http://blog.mdwoptions.com/options_for_rookies/
 

Mark
http://blog.mdwoptions.com/options_for_rookies/
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Hey, great site btw, thanks.

Yeah it's not really easy, and I've had some pretty good success at it, I've also taken losses as well.

I forgot to mention that my target holding period is usually 1 day and up to 5 days at most for the options I buy. It depends on a number of different factors, price action, news, low volume days, instinct, etc.

Most of the strategies that a lot of other options buyers/sellers employ have a longer-term holding period and tend to have larger funds to employ the strategies at a good profitability level. I trade a smaller amount and my needs vary on a month to month basis.

Just stating that's all.

Thanks for the link again, has some good opinions/ideas.

-troll
 
Mark,
Interesting discussion beginning here-- I think Codetroll can minimize his option related risks if he plays fairly deeply in the money options with little time value. If his time horizon is reasonable, then the risk is primarily related to the stock price movement. I think if the delta is above .75 or so, he should be able to capture most of an upward movement so long as that movement is noticeable (say $5 or more).

Of course, options can also help limit the dollar value of a negative movement in the stock, so it works both ways. As you know, if a stock or index declines in value the volatility increases (usually), and the delta also becomes smaller which limits the losses somewhat. This is one reason that option investing, although leveraged, can actually be better at reducing the dollar value of losses, providing that the trader uses good discipline in keeping the trade size at a comfortable level.

I think one of the most fascinating things with options is actually the level of control that you have over the risks. You can tailor your position in ways that control which risks you are willing to take, although I must point out that you cannot eliminate all the risks unless you are in a position that has already moved favorably for you. Then you can protect your gains.

With positions that are only stocks, you have two choices--long or short, and sometimes you can only go long. Your delta is always either -100 or +100. Your volatility risk will hurt you directly if the stock goes down, and the only way to truly protect your gains is to sell (or buy put options!).
 
You are looking for trouble trying to do this. Options trading is trading in 4 dimensions. If you like math/science and money :) you will love options if you do not like taking the time and doing it right you will lose money and hate options.


Options is not like daytrading, it is a more methodical way of trading in my option you do your models, plan your strategy and execute it is not like daytrading. (ie more like Chess vs Checkers)
 
Quote from codetroll:


I forgot to mention that my target holding period is usually 1 day and up to 5 days at most for the options I buy.

-troll
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One obvious point is that you should try to trade options that are very liquid and which have fairly narrow bid-ask ranges.

Overcoming that b/a spread can be a real problem.

The idea of using higher delta options sounds right to me. It minimizes the effects of IV changes. The problem is that these options are sometimess far less liquid than ATM.

Mark
 
Thanks John and yes I agree a lower theta does help.

I also agree Mark that the bid/ask is also one thing that gets in my way a lot, sometimes the move that I predict is not large enough to affect the option price to the degree I want. (i.e. 7% gain versus 14% anticipated).

The way I've been trading my options is by buying higher deltas and with a larger expiration, depending on if I feel the stock is ready to pop or if there is price compression, with chance of reversal, then I buy further out in time (i.e. it's going to take longer to get get where I think it's going to go).

As for liquidity/trading, my general rule of thumb that I use is to never purchase an option with less than 10 days left, sometimes 15 days (depends on what the stock is doing). If < 10 days, purchase next month or even the month thereafter. I usually trade only DOW stock options or a few other stocks that I'm familiar with in other indexes.

Question: What do you think would be a $ amount that would cause a liquidity problem, for lets say a DOW company? I've been told be some people that right around $40,000 you start running into execution liquidity problems. I've never put in an order that large before, but at what point would you run into a problem? Just curious, so that I can gauge it from a risk perspective (filling issues, etc.)

Thanks.


Just a side note:What is interesting is that what I've found trading options on a day to day basis, is that the option actually begins to act as an indicator in and of themselves. Yes, I know derivative specialist are some of the most skilled at pricing in the world, but it's interesting that it can be seen in the price action.

For instance if I buy a CALL with the stock price near $19 and expect a rise to $20, roughly 30-35% return (back hand / rule of thumb) but the option pricing acts funny and doesn't rise fast enough or to the degree I anticipated, I've noticed recently that it is fairly accurate that the stock is going to reverse direction soon (within a couple of hours or the next day). Almost like the market makers/buyers aren't stepping in to drive it up to what it should be. What I'm trying to say is: when the option acts "funny" the stock does something, usually something that would put your option in jeopardy of being profitable.
 
Quote from codetroll:




Question: What do you think would be a $ amount that would cause a liquidity problem, for lets say a DOW company?

I doubt you have enough money to make that happen. Market makers are accustomed to taking down 1000 lots with nary an eye blink. And much larger orders - say 50,000 contracts - don't just arrive on the options floor. they have been 'shopped' off the floor and there are probably enough buyers or sellers to fill the order - even if the market makers don't want to participate in the trade.


I've found trading options on a day to day basis, that the option actually begins to act as an indicator in and of themselves...

... the option pricing acts funny and doesn't rise fast enough or to the degree I anticipated...Almost like the market makers/buyers aren't stepping in to drive it up to what it should be.

There is no 'should be.'

First market makers are not likely to drive the price higher unless there are outside buyers. They want to buy options at good prices [I was a CBOE MM for 20+ years.] and if no one else is driving the price higher, neither do they. That's accomplished by reducing the volatility estimate used in the computer that calculates the bid/ask quotes.

Second, when a stock rises, especially in today's environment of relatively high implied volatility, that IV drops - sometimes rapidly - when the stock rallies. You may find a call with a 30 delta really has a delta of 5 (or even less).
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Mark
 
Hey Mark, great to know about the liquidity thing. I had thought it wouldn't be that big an issue, I guess when you mean it was "shopped off" you mean it went the dark liquidity way? That's what comes to mind. Not like I'll ever get to that point anyway. <shrugs>

Yeah I agree, same thing with stocks, momentum breeds momentum (supply/demand) and the whole "pushing scenario". The IV risk can be mitigated by going with a higher delta to begin with I suppose like in the previous posts, I do it anyway and have never run into a big problem, yet (knock on wood).

My new question now turns to lets say an intraday trade. In order to lets say "reduce" one's risk and not carry overnight let's say or if that was the strategy, etc. If for instance we had a quick sell off or quick over reaction, in order to capture that movement, would you think one would run into an issue with hitting the BID or ASK depending on how one was trading. Or would one run into a problem with partial fills? I've looked at the lvl2 for the options and it appears to have, like any lvl2 to have pent up orders, not sure if a single order would be able to capture a large amount or not.

I've only had to hit the bid/ask a couple of times to get me out quickly, usually to lock in gains before a turn around in the stock. Just wondering, or is it like you said still, filling a big order is still a no-problem scenario for these guys.

Also, what software/service would you recommend to be able to recalculate the greeks real time? Just FYI, I use quotetracker to do all my trades and my broker's option platform to calculate the move, usually on a close by close basis.

Thanks again, great insight.
 
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