The Perfect Option position

[asiaprop]

"relatively" risk free, "get money if the underlying is flat, moves up or moves down."

Congratulations Buddy, you just found the secret to unlimited wealth. My God....

Quote from spindr0:

My previous response was geared toward the proposal that Maverick's "ideal trade" was relatively risk free and would "get money if the underlying is flat, moves up or moves down." While that's true if it moves up or down the ideal amount or does a 1/2 gainer on the 12th day of odd months, other than conversions, reversals, etc., there just aren't any positions that fill your coffers with low to no risk. Come to think of it, conversions and reversals don't fill your coffers.

Your opinion is on the money. Constructing a position with so many legs involves a lot of slippage and commissions. Mentally managing it is challenging and if you start adjusting legs or scalping portions of it, it mutates into something that ceases to resemble what you started out. It can then become hard to comprehend what your position represents and where you stand unless you're agile with the Greeks and you're managing it that way (which I can't).

I don't know a thing about Maverick's previous posts but in all fairness, there is something to be said about positions have a risk graph that is "W" shaped with modest maximum losses in the body and a potential windfall at the wings. But with 8 legs?

If this was a pre-earnings idea where one was getting some extra IV bump from the near month, I'd be more interested. But I'd look to achieve it with fewer legs (4), perhaps one of those ratioed double diagonals that you like?

And thanks for the kind words

 

[asiaprop]

...haha, exactly right, all it counts is your risk, no payoff diagrams needed, no multi legs in your head. Thats why I say you can express the same strategy with 1-3 options instead of 7-8. The only reason dealers have so many options in their book is market making. The actual risk often looks identical (I slightly simplify here) to a simple straddle, strangle, call or put. Nothing magical to it.

Quote from dmo:

I certainly agree with the KISS principle and the potential cost of having positions with many legs.

But the reason I can manage a position with 50 legs as easily as a position with 2 legs has nothing to do with any ability to juggle multiple legs in my head simultaneously. It's because I stopped trying to do so long long long ago.

For me, to manage any position, regardless of its complexity, comes down to a few simple numbers - total position delta, gamma, vega and theta. It's the same for a position with 3 legs or a hundred legs.

I would compare learning to manage a position this way to learning to fly a plane by instruments rather than by "eyeball." Learning to trust your instruments so you can fly safely even through fog and storm is an important step for anyone who wants to become an expert pilot, and learning to trust your "instruments" (greeks) and fly your position using them alone is a vital skill for anyone who wants to attain expert option skills.

The one additional piece of info I need to know to manage my position is my net position at each strike. In other words, looking at the 90 strike for example, it is the same to me whether I am long 50 calls and short 100 puts, long 50 puts and short 100 calls, or long 500 puts and short 550 calls. In each case I am net short 50 at the 90 strike, which is all that I need to know. That information tells me whether I will be getting longer premium (gamma and vega) or shorter premium as the underlying moves up or down.

I also treat positions in different months as separate positions. That's particularly true of options on futures positions, where the underlying in each month is truly a separate contract that can move quite differently from the other months.

 

[asiaprop]

very good points I think. People get fuxxed much more often than they care to remember. One leg expires a day earlier than the others (not possible on listed but OTC, for example), you're short gamma but the stock goes nuts hours before expiration and it freaks the heck out of you...thousand things can happen the more complex the strategy the higher the probability of a fuxxup. This probability is almost all the time more or less correctly priced into the option strategy as well making it worthless to believe you got something for free.

Quote from jones247:

A potential problem with this strategy is the fact that there's a strong possibility of being pinned at expiration, or having only a short leg exercised while ITM, plus having the long wings expire OTM... What can you say...

No Free Lunch...

 

[dmo]

Quote from MechTrade:

Hey DMO,

Sorry to Quote you a 2nd time, but there was something familiar about your comments about managing complex options position(s) by greeks.

A couple of months ago I stumbled across a website where the operator promoted the concept of spending 10 or 15 minutes each morning to 'analyze' his portfolio of his option positions by the greeks. He was promoting the concept that the greeks were the simple key to his success in managing his portfolio, and his tone was very similar to your post, indicating that the portfolio greeks were the key.

But as I recall, the guy wanted about $100 per month from you to join his "inner circle group" for it to be worth his time to share his techniques.

While 'flying a plane by instruments' is a little beyond 'Flying 101", would you be willing to share a little more about Greek Management?

If you are willing to discuss this, it probably should merit its' own thread.

Mech

I'm happy to discuss flying by greeks or anything else. I'm not sure it merits its own thread but if there's anything you want to know, ask away.

I agree with Asiaprop that a retail trader would never want a position with dozens of legs - transaction costs would eat you alive. I also agree that the only reason to have such a position is if you're a market maker. That was my situation when I was in the CBOT T-bond options pit. As a local (futures and futures options equivalent of market maker) you make markets on puts and calls at every strike and every month all day long and before you know it you have a position of thousands of options at every strike in every month. There is no way on Earth you could manage such a position other than by greeks, so we all became very adept at doing so.

At some point I left the floor and began trading as a retail customer. I soon realized that strategies and approaches appropriate for the floor don't work as a retail trader, and so I completely changed my trading style. Now I generally have few legs on any one underlying.

What never changed though is the way I visualize an options position - whether it is 80 legs or 2 legs. I see it as:

1. The overall delta, vega, gamma and theta.

2. The location of my premium, i.e., at what strikes I am long premium and at what strikes I am short premium.

3. The implied volatility of each strike.

One huge advantage of doing it this way is that it frees you from the strait jacket of being tied to cookie-cutter strategies. Call spreads no longer need be 1 by 1, or a "known" ratio such as 1 by 2. If 19 by 33 gives you the risk profile you want, then fine, no problem. Rather than being tied to "iron condors" or "butterflies," you can simply decide to be short the middle and long the wings, if that's what makes sense, then choose the strikes that are the most liquid, or the cheapest, or whatever you want. The option game changes from being 2-dimensional to 3-dimensional.

Moreover, when you start to see options this way, you develop a sensitivity to each option's personality. You start to see when they are behaving strangely and what opportunities that might suggest. You also have access to the whole universe of possibilities to play that anomaly. You find that the best strategy is never a cookie-cutter strategy, but rather a custom strategy hand-crafted from the options reality of that moment.

 

[Bben1006]

An inventory mamangement of sort--rather than having a specific position/strategy--am i correct? Does this also free you from having a pre-specified exit strategy?

BB

Quote from dmo:

I'm happy to discuss flying by greeks or anything else. I'm not sure it merits its own thread but if there's anything you want to know, ask away.

I agree with Asiaprop that a retail trader would never want a position with dozens of legs - transaction costs would eat you alive. I also agree that the only reason to have such a position is if you're a market maker. That was my situation when I was in the CBOT T-bond options pit. As a local (futures and futures options equivalent of market maker) you make markets on puts and calls at every strike and every month all day long and before you know it you have a position of thousands of options at every strike in every month. There is no way on Earth you could manage such a position other than by greeks, so we all became very adept at doing so.

At some point I left the floor and began trading as a retail customer. I soon realized that strategies and approaches appropriate for the floor don't work as a retail trader, and so I completely changed my trading style. Now I generally have few legs on any one underlying.

What never changed though is the way I visualize an options position - whether it is 80 legs or 2 legs. I see it as:

1. The overall delta, vega, gamma and theta.

2. The location of my premium, i.e., at what strikes I am long premium and at what strikes I am short premium.

3. The implied volatility of each strike.

One huge advantage of doing it this way is that it frees you from the strait jacket of being tied to cookie-cutter strategies. Call spreads no longer need be 1 by 1, or a "known" ratio such as 1 by 2. If 19 by 33 gives you the risk profile you want, then fine, no problem. Rather than being tied to "iron condors" or "butterflies," you can simply decide to be short the middle and long the wings, if that's what makes sense, then choose the strikes that are the most liquid, or the cheapest, or whatever you want. The option game changes from being 2-dimensional to 3-dimensional.

Moreover, when you start to see options this way, you develop a sensitivity to each option's personality. You start to see when they are behaving strangely and what opportunities that might suggest. You also have access to the whole universe of possibilities to play that anomaly. You find that the best strategy is never a cookie-cutter strategy, but rather a custom strategy hand-crafted from the options reality of that moment.

 

[dmo]

Quote from Bben1006:

An inventory mamangement of sort--rather than having a specific position/strategy--am i correct? Does this also free you from having a pre-specified exit strategy?

BB

I'd say it's a way of stripping an option position down to its essentials so you can see what it really is and how it behaves. It's like looking at an x-ray of the position so you can see what it's really made of.

On the surface a 90 put and a 90 call may look completely different. But if you peek under their skirts you'll see they're identical except in the most superficial ways. When you look directly at option greeks it's like looking at the stripped-down version, with all the superficial covering removed. All that's left are the bare essentials. Makes it so much easier to see what you've got.

 

[Bben1006]

DMO
Do we see here an idea/suggestion for a new instructional video?
~BB

Quote from dmo:

I'd say it's a way of stripping an option position down to its essentials so you can see what it really is and how it behaves. It's like looking at an x-ray of the position so you can see what it's really made of.

On the surface a 90 put and a 90 call may look completely different. But if you peek under their skirts you'll see they're identical except in the most superficial ways. When you look directly at option greeks it's like looking at the stripped-down version, with all the superficial covering removed. All that's left are the bare essentials. Makes it so much easier to see what you've got.

 

[dmo]

Quote from Bben1006:

DMO
Do we see here an idea/suggestion for a new instructional video?
~BB

You probably just wanna see what's under the option's skirts you pervert!

Actually you're right, it's a very rich area for instructional videos. I don't have the time right now but one of these days...

 

[spindr0]

Quote from dmo:


What never changed though is the way I visualize an options position - whether it is 80 legs or 2 legs. I see it as:

1. The overall delta, vega, gamma and theta.

2. The location of my premium, i.e., at what strikes I am long premium and at what strikes I am short premium.

3. The implied volatility of each strike.

What do you use to keep track of this? Spreadsheet? Proprietary program? Retail program? Broker tools? Thx

 

[dmo]

Quote from spindr0:

What do you use to keep track of this? Spreadsheet? Proprietary program? Retail program? Broker tools? Thx

I wrote a program in an ancient language called Quickbasic years ago, and still use it to this day. I also use Hoadley's options analyzer and Excel functions.