Spreads vs naked

[chrismontez]

Just killing time with this observation. In looking over scores of option trades over the last 6 years, I have come to the conclusion that I would have been better off with naked options instead of spreads. I could have kept the risk the same, and would have made much more $. For instance Nov bear put spread on BAC, long the $27.50 @ $300, short the $25.00 @ $200. Risk $100 to make $150. Three contracts to make $450 profit on $300 risk whereas one $27.50 put would have yielded $1250 return. Same with numerous trades on the QQQQ's, OEX and other stocks.

Anyone else take a good look at their trading record comparing a naked option for the same risk as the cost of their spreads and the closing price near option expiration to see which would have yielded a higher return over the long haul?

 

[nazzdack]

1) You're looking back upon the past with a sense of certainty. Don't do it.
2) You could have done "directional" trades when the market was moving directionally but you didn't. Let it go.
3) Now, with the market possibly being in a trading range mode, option spreads may be a better way to trade. A year from now, you'll know for sure.

 

[dagnyt]

Quote from chrismontez:

I have come to the conclusion that I would have been better off with naked options instead of spreads.

1) I must make this point for anyone reading this post: he is referring to buying naked options, NOT selling them.

2) Nazzdack is correct and I concur.

3) No one strategy works best forever. Be flexible in your approach.

4) Giving an example in which you could have sold a long option at its highest point proves nothing.

5) Spreads are used to reduce risk. If you don't like reduced risk, if you prefer to gamble and seek higher profits, then go ahead and buy options. Just understand the difference.

Mark

 

[u21c3f6]

Your observation is correct.

If you can make money with spreads, you can make more money without the spread. The spread costs you in more commissions and the amount you "lose" by having the short option.

The spread will tend to have a smoother P/L curve than just owning the long option. It depends on whether you have the risk tolerance for the more volatile P/L of just owning long options IMO.

 

[chrismontez]

"Spreads are used to reduce risk. If you don't like reduced risk, if you prefer to gamble and seek higher profits, then go ahead and buy options. Just understand the difference."

Whenever I've brought up this topic I get responses like this. Option traders who think that risking $500 on a spread is different than risking $500 on a naked potion. Five hundred is five hundred no matter how you risk it. In my particular case, I enter trades that I think are going to make a movement of size and in reviewing my historical data I can say with certainty that on the long option spreads I have entered over the last 6 years, I would have made more money by taking a smaller position of naked options than taking a larger position on a spread, both at the same cost.

My question was if anyone else had actually done the math on their trades to comment with certainty that they made more money, with the same risk (money on the table), by trading spreads. To keep it simple, I am refering to vertical spreads.

 

[u21c3f6]

Quote from chrismontez:

My question was if anyone else had actually done the math on their trades to comment with certainty that they made more money, with the same risk (money on the table), by trading spreads. To keep it simple, I am refering to vertical spreads.

Yes, I have done the math. I now almost always only buy an option and not a spread (spreads are still useful in certain situations). I found that I was giving too much away with the short option as well as the additional commissions to be worth the "reduced risk". All the reduced risk did for me was to smooth the P/L. The end result was lower profits. The smoother P/L is not worth the reduced profits IMO.

 

[dagnyt]

Quote from chrismontez:

"Spreads are used to reduce risk. If you prefer to gamble and seek higher profits, then go ahead and buy options."

"Whenever I've brought up this topic I get responses like this. Option traders who think that risking $500 on a spread is different than risking $500 on a naked potion"

My question was if anyone else had actually done the math on their trades

1) You are the one making the mistake by assuming that the same amount of cash would be placed at risk.

The intelligent option trader - one who understands risk - knows that you do not buy 30 spreads at $100 each instead of 10 naked long options at $300 each.

You buy an equal quantity and invest LESS money. In my example, that's $1,000 instead of $3,000. That's why spreads truly offer less risk in return for less potential reward.


2) Our replies do not have to be limited by the question. Why? Because many option newbies read these pages and sometimes explanations are necessary for <i>them</i>.

Mark

 

[4XQs]

Looks like you're confusing the initial premium paid with risk, dagnyt. I assume you use stoploss with spreads?

 

[damon_achey]

Possibly try to also attribute what greek(s) accounted for most of the gains. It may be that you're good at earning from long gamma for example and that you'd get more bang for your buck in the long uncovered option than from the spread, at the expense of having more vega risk.

 

[dagnyt]

Quote from 4XQs:

Looks like you're confusing the initial premium paid with risk, dagnyt. I assume you use stoploss with spreads?

1) When you pay $1,000 for 10 spreads instead of $3,000 for 30 spreads, you have less at risk and (obviously) less to gain.

When you pay a premium for an option or an option spread, that premium <i>is</i> the risk.

Where is the confusion?

It was the original poster who assumed that one would invest the same number of dollars - regardless of whether he was buying naked longs or buying a spread.

2) I believe that options are ill-designed for stop-loss orders - and do not use them. But one can use a stop loss on the underlying stock.

I posted my reasons why this is true here:
http://blog.mdwoptions.com/options_for_rookies/2009/01/the-merits-of-buying-iron-condors.html

Click on 'comments' at the end of the post.

3) I do manage risk by cutting losses, but not with stop-loss orders.

Mark