The Perfect Option position

Maverick74 · Nov 13, 2003

Quote from corvus:

First, I really enjoyed this thread thanks everyone for contributing.

As a newbie with options, I'd like to know more about position management...legging in, rolling months over, and exiting both when things have gone well AND when you've made a mistake. Strategies are excellent to cover, but what of managing them?

Managing a position well really comes from experience. No short cuts there. After you have managed so many positions you will get a feel for what works for you and what doesn't. I always try to err on the side of reducing risk whenever possible.

Legging in, well, I think you need to be really careful here. Don't be greedy. When I leg into a position I try to pick of the market for a tick, just one tick and get both sides on with maybe 10% of my total position. Then let the position move and add the rest as the mkt moves my way. This is why its always good to put on your long premium first because you can use your gamma to leg into the rest of your options. Never sell your naked options first.

Whenever you have a nice profit and want to get out, well thats easy and fun because again, you can leg out of your position with the mkt, ie selling your calls on the rallies buying back your puts and so on, again, using your gamma to get out. When a position goes against you, sometimes its better to find out where the bleeding is first and contain it rather then just jump ship, ie can you put some stock on first or take off part of the position to get yourself neutral so you can work out of it at better prices. You always want to work your position and not put it all on or take it all off at one time. I normally spend up to a week to get in and out of a position.

Rollovers, same thing with the gamma, use your gamma to work for you and roll your options over one at a time, don't take the whole thing off at once or put the new month on all at once, do it one piece at a time and don't wait till the last minute obviously.

VVVWaveRiderVVV · Nov 13, 2003

Quote from inandlong:

You didn't ask me, but I'd like to post on it anyway.

The idea that revealing a strategy dilutes its effectiveness is complete bunk. Considering the number of optionable vehicles alone makes any concern about the viability of this strategy moot. Add to that the fact that you could show this to 100 different traders and they would trade it 100 diffrent ways...

The question was open to anyone. However, I did a lousy job of making myself clear. For the most part, I was joking about the bad guys taking away the edge. I believe it can happen, but it is not as prevalent as everyone thinks. I guess I'm a little rusty on posting and ended up disguising my sarcasm too well

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VVVWaveRiderVVV · Nov 13, 2003

Quote from Maverick74:

No two people ever do the same thing. The point is it's not the strategy that makes you money but the execution.

And what I have learned is that most people can't execute their way out of a paper bag.

I'll be more then happy to keep discussing this strategy...

Can we talk about execution for a while? What might one need to look at to ensure a good execution? You mentioned making sure that the skew is as flat as possible. What else would you consider before putting this trade on?

BTW, I've really learned a lot in this thread and have enjoyed it immensely

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dagve · Nov 13, 2003

Maverick, the position you explained is a good one. I just wanted to add that you dont have to sell the straddle and buy the strangle in the front month to create the fly you are synthetically long the 95/100/105 call or put spread. What Im trying to say is that your front month fly for a 3 dollar credit is also simply the 95/100/105 call or put butterfly for a 2 dollar debit. Same risk profile. I enjoy your posts.

inandlong · Nov 13, 2003

Quote from VVVWaveRiderVVV:

The question was open to anyone. However, I did a lousy job of making myself clear. For the most part, I was joking about the bad guys taking away the edge. I believe it can happen, but it is not as prevalent as everyone thinks. I guess I'm a little rusty on posting and ended up disguising my sarcasm too well .

No VVV', I should have included I felt you were being funny. It seemed so to me anyway. But it is a topic that comes up now and then and one I wanted to post on.

My bad.

As for the post about execution... I'm with you. I have learned a lot and been forced to learn in order to keep up. As Mav has made execution the important variable, I sure would like some discussion on that too.

Hopefully metooxx can add to this discussion as well.

Maverick74 · Nov 13, 2003

Quote from dagve:

Maverick, the position you explained is a good one. I just wanted to add that you don't have to sell the straddle and buy the strangle in the front month to create the fly you are synthetically long the 95/100/105 call or put spread. What Im trying to say is that your front month fly for a 3 dollar credit is also simply the 95/100/105 call or put butterfly for a 2 dollar debit. Same risk profile. I enjoy your posts.

Yes but the purpose of putting on the fly on the front month is to create a position that actually has positive theta from beginning of the trade. There are no real advantages to having a fly on the back month because theta is not a concern there. By putting on the fly on the front month, you actually will create a position that will make you money if the stock sits still or moves. It's only at front month expiration where you have to make a move especially if the stock is at the wings of the fly because that is where you have a negative profit zone for a few pts.

Maverick74 · Nov 13, 2003

Quote from inandlong:

No VVV', I should have included I felt you were being funny. It seemed so to me anyway. But it is a topic that comes up now and then and one I wanted to post on.

My bad.

As for the post about execution... I'm with you. I have learned a lot and been forced to learn in order to keep up. As Mav has made execution the important variable, I sure would like some discussion on that too.

Hopefully metooxx can add to this discussion as well.

I concur on getting metooxx in here. He could probably take me to school on options which would be a lot of fun for me. So get him in here!

dagve · Nov 13, 2003

I obviously didn't explain what I meant clear enough. I'm not advocating fly's in the back months. I wanted to point out that the fly that you recommend initiating in the front month is an iron butterfly (+1 95 p/-1 100c/-1 100p/+1 105c). I am suggesting putting on the synthetic equivalent as an alternative ( +1 95c/-2 100c/+1 105c or +1 95p/-2 100p/+1 105p). Same break even profile and greeks profile.

Maverick74 · Nov 13, 2003

Quote from VVVWaveRiderVVV:

Can we talk about execution for a while? What might one need to look at to ensure a good execution? You mentioned making sure that the skew is as flat as possible. What else would you consider before putting this trade on?

BTW, I've really learned a lot in this thread and have enjoyed it immensely .

Skew is really important here because in general you have what is called a volatility smile working against you. If you don't know what that is just picture a big fat smile on a graph. At the bottom of that graph and the bottom of the smile its flat, that is where the ATM strike is and where the vol tends to be the lowest. But as you move out to the OTM calls and the OTM puts the Vol skews higher with each strike therefore creating the proverbial volatility smile. This works against you because you are in essence selling low vol and buying higher vol on the wings.

Your goal should be to try to find stocks where the skew is as flat as possible. Of course by legging into these options you will be synthetically flattening the skew by getting better prices. But there are a lot of scanners out there that will scan just for skew and will provide you with lots of good plays to try this spread on.

The other thing I would look for is find strong stocks! Not weak stocks. You want to put on plays where the vol is very very low because remember, once the stock moves out to the wings you will now have a long vega position and will therefore be vulnerable to decreasing volatility. Also look for stocks that are in a tight range and not moving much so that if they do break out you might get a stronger move and more follow through.

So to sum up, I would look for stocks near 52 week highs that have low vol and flat skew.

Maverick74 · Nov 13, 2003

Quote from dagve:

I obviously didn't explain what I meant clear enough. I'm not advocating fly's in the back months. I wanted to point out that the fly that you recommend initiating in the front month is an iron butterfly (+1 95 p/-1 100c/-1 100p/+1 105c). I am suggesting putting on the synthetic equivalent as an alternative ( +1 95c/-2 100c/+1 105c or +1 95p/-2 100p/+1 105p). Same break even profile and greeks profile.

Yes you could that but by being long both the 95 call and 105 call you are putting in a long bias into the position. Where as I just have bought the 105 call and the 95 put so I have no bias to direction.

What you are describing is the same as a long butterfly where as my position is more like a condor on the front month since I am selling the ATM straddle and buying the strangle, I am just doing it with both the calls and the puts to create neutrality.

With your spread I would actually want the stock to move to the wings where as with mine I want the stock to sit still, I get hurt at the wings. Thats the same as with a long butterfly, where you want the stock to rise to the sold wings to reach the maximum amount of profit.

I hope this doesn't confuse anybody. Remember, whenever you sell options that is where you want the stock to go at front month expiration. So if you sell the wings, you want the stock to go to the wings, if you sell the ATMs, then you want the stock to sit still.