Spreads vs naked

Quote from Nanook:

Correction: He was buying DITM bull call vertical spreads (debit).
http://www.elitetrader.com/vb/showthread.php?s=&threadid=126947 "I use almost exclusively Deep in the money Bull Call Vertical spreads."
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The above thread should be required reading for anyone considering options but it needs added discussion.

In my opinion, the real issue in that thread was only indirectly touched on by one poster that mentioned percentages. There was no discussion of edge. I see threads, as well as many books that discuss how to "adjust" option strategies but IMO what good is an adjustment if that has no edge either? This one topic of edge is a book in itself.

I do not approach options as an investment (there are exceptions such as using them to hedge other "investments"), I view options as live sportsbook gambling and use the same techniques that I use in my sportsbook wagering. There is a lot to write which I can't do at one sitting. I'll start the discussion with this:

Let's assume the following:

Two guys are arguing, one says it is better to buy options, the other says that it is better to sell options. They agree to a contest. They will throw a dart at the option pages and the one guy will buy the option and the other guy will sell the option. They will do this 100 times. The first dart throw lands on ZZZ Mar 09 Call. The spread is 1.95-2.05. So the one guy buys one contract for $205 and the other guy sells one contract for $195. Not considering commissions, if each guy started with $1,000 and this process was repeated 100 times (different underlying, different expiration,could be call, put and could be different pricing but assume same spread), how much money (on average) would each guy have after all 100 options expired?
 
Quote from Nanook:

"I use almost exclusively Deep in the money Bull Call Vertical spreads."
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And we all know that's equivalent to selling FOTM put credit spreads - same strikes and expiration as the call spreads.

Mark
 
Interesting discussion,but I think you guys are missing the point...

First and foremost,there is no hard fast rule regarding spreads vs naked options.We all know that the level of implied vol should/will be the major factor in determining which path we choose.The same could be said for options vs stock...

With that siad,one should be comparing apples to apples,or should I say Delta to Delta.If your position sizing algo leads you to be long 1000 shares of AAPL,you should be comparing

1000 shares long
1000 delta long -naked option
1000 delta long- option spreads

There is no right or wrong answer.But one should first have some view on implied vol,vega risk and theta....

If you are a directional trader who employs stops,than the same $ stop should be employed with option positions.The difference is one will need to factor in Theta and vega risk.
 
They agree to a contest. They will throw a dart at the option pages and the one guy will buy the option and the other guy will sell the option.
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How much did the newspaper cost?
 
When I started this post I was just pointing out that in reviewing MY trading history and buying options as a way to make money on an anticipated move, most of the positions that went the way I thought they would, went that way in a BIG way. Ex. MSO from $8 to $40, GSF from $50-$90's, drop in BAC from $32 to $12, QQQ's from $40's to $30's etc..., and that in my case having $300-500 in naked calls or naked puts would have returned much more money than having 3-4 spreads that cost me $300-500 and only returned 50-100%

This is certainly different than systems option traders use to capitalize on range bound stocks etc...


But for the age old arguement of buying vs selling options: an equity can only move 5 ways, and the seller makes money on 4 of those ways, the buyer on 1.
 
Quote from chrismontez:

But for the age old arguement of buying vs selling options: an equity can only move 5 ways, and the seller makes money on 4 of those ways, the buyer on 1.
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What is your conclusion from what you wrote above?
 
"If you are a directional trader who employs stops,than the same $ stop should be employed with option positions."

I don't know if I agree with this, but then again I'm a piker taking small positions. If you buy options 2-3 months out, even if the general trend goes the way you anticipate you will have spikes and dips. And the stronger the trend, the stronger the spikes and dips. So unless you bought at the bottom or top, you can expect to see your position stopped out before it goes the way you anticipated. A 50% drop in price on the options is pretty common. I ran into this problem on my OEX puts this past September and missed the big drop. True I could have gone back in, but I have trouble buying back my options at a higher price.

Well my USO position I bought today is down so I think the ski slopes are calling me.
 
"What is your conclusion from what you wrote above?"

I've had this discussion on ET with traders who are much more knowledgeable than I am and who think I am wrong. But in my simpleton view, if I know I can win 4 out of 5 times by selling options, and I have the resources to offset any short position the same way MM's do ( buying the underlying on short calls, selling the underlying on short puts) seller's win over the long haul.
 
Quote from taowave:

one should be comparing apples to apples,or should I say Delta to Delta.If your position sizing algo leads you to be long 1000 shares of AAPL,you should be comparing

1000 shares long
1000 delta long -naked option
1000 delta long- option spreads

There is no right or wrong answer....
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I don't believe that's a winning strategy over the long-term.

There's quite a difference in results when buying options vs. buying stocks. One reason for buying options is the leverage. It's not necessary to buy 1000 deltas. By buying options, the trader invests less money and

1) decreases the probability of success

2) increases the potential return on investment

c) limits losses - despite the fact that losses occur much more often

When deciding to buy an option spread, the idea is to hedge - reduce risk. I agree with your opinion that owing a spread is not an automatic decision and that IV, among other factors, must be considered. But, <i>once the decision is made</i> to buy spreads instead of individual options, there is no need to increase the size to provide an equal delta position. That's just poor strategy, IMHO.

Once you decide to take a position via options, there is an appropriate number to buy. Just because you hedge that purchase by doing a spread does not mean you increase the quantity. In fact, it's right (IMHO) to trade the same number of contracts. That provides a true hedge: less risk, less reward; higher probability of earning a profit.

Mark
 
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