There's no difference buying short term options vs. buying LEAPS?

crgarcia · Sep 29, 2009

For long term investing.

Nassim Taleb in his book Dynamic Hedging says that while short term options have more time decay, they also have more gamma, thus more profit potential?

Besides you are exposing (risking) much more money with LEAPS?

dagnyt · Sep 29, 2009

Quote from crgarcia:

For long term investing.

Nassim Taleb in his book Dynamic Hedging says that while short term options have more time decay, they also have more gamma, thus more profit potential?

Besides you are exposing (risking) much more money with LEAPS?

A lot depends on how you define risk.

There is the risk of losing all, or almost all of the investment. That makes the shorter-term option more risky because of the more rapid time decay.

Then there's the probability of loss. That's also a measure of risk. Short-term options tgive you less time to earn a profit and he investor loses more frequently. Thus, are more risky from this point of view.

Then thee is the amount that can be lost. By that measurement, LEAPS are riskier.

It's also reasonable to discuss risk compared with reward. By that measure, the near-term option and it's positive gamma, makes owning them much less risky.

One problem of discussing risk is that the term is seldom defined.

Mark

crgarcia · Sep 30, 2009

Quote from dagnyt:

Short-term options tgive you less time to earn a profit and he investor loses more frequently. Thus, are more risky from this point of view.

But, according to Taleb, short term options have much more gamma (and also delta), which compensates the time decay.

LEAPS tend to have higher implied volatilities (and this IVs also decay with time).

LEAPS have much, much more Vega, so if IV drops, you lose.

Quote from dagnyt:

One problem of discussing risk is that the term is seldom defined.

Mark

So true.

wayneL · Sep 30, 2009

People tend to compare holding said options to expiry.

There is no law that says you can't roll out the shorter term option (or the LEAPS for that matter) before expiry... lets say 4-6 weeks before.

This makes it an entirely different equation.

FWIW

circadian · Sep 30, 2009

Quote from crgarcia:

For long term investing.

Nassim Taleb in his book Dynamic Hedging says that while short term options have more time decay, they also have more gamma, thus more profit potential?

Besides you are exposing (risking) much more money with LEAPS?

Don't forget the Rho. Interest rates will be higher by this time next year, and that gives you a little somethin-somethin.

MasterAtWork · Oct 1, 2009

Quote from crgarcia:

For long term investing.

Nassim Taleb in his book Dynamic Hedging says that while short term options have more time decay, they also have more gamma, thus more profit potential?

Besides you are exposing (risking) much more money with LEAPS?

"they also have more gamma, thus more profit potential?"
They also have more gamma risk

.
NNT just states that writing a short term option has the same expected profit (assume 0 interest rates) as a long term option, except that you earn less premium for the risk you take.
Short term options have bigger time decay BECAUSE they have bigger gamma risk.
Leaps have almost no gamma risk but a serious vega risk.

crgarcia · Oct 1, 2009

Quote from MasterAtWork:

"they also have more gamma, thus more profit potential?"
They also have more gamma risk .
NNT just states that writing a short term option has the same expected profit (assume 0 interest rates) as a long term option, except that you earn less premium for the risk you take.
Short term options have bigger time decay BECAUSE they have bigger gamma risk.
Leaps have almost no gamma risk but a serious vega risk.

Look at the Alpha (gamma per theta), unless mispriced short term options have similar Alphas to LEAPS.

MasterAtWork · Oct 1, 2009

Quote from crgarcia:

Look at the Alpha (gamma per theta), unless mispriced short term options have similar Alphas to LEAPS.

Right, assuming zero interest rate, that's why bigger gamma/bigger theta for short term options remains the same as lower gamma/lower theta for long term options.
Gamma and theta walk along the same way. The additional risk for LEAPS is vega something.

Hester · Oct 3, 2009

Quote from crgarcia:

For long term investing.

Nassim Taleb in his book Dynamic Hedging says that while short term options have more time decay, they also have more gamma, thus more profit potential?

Besides you are exposing (risking) much more money with LEAPS?

Of course theres a difference. You cannot invest for the LONG term with SHORT term options. Unless you want to roll out your position 15 times. If you like a stock for its long term prospects, assuming long term is 2-3 years, then you cannot buy short term options on that stock simply because they expire too soon.

Also, short term options have more gamma which means more profit potential, but it also means more loss potential if your investment or trade moves against you. This makes short term options more risky than leaps.

wayneL · Oct 4, 2009

Quote from Hester:

Also, short term options have more gamma which means more profit potential, but it also means more loss potential if your investment or trade moves against you. This makes short term options more risky than leaps.

You might want to recheck your assumptions there.

Higher gamma in a call gets you fewer deltas as the underlying moves down. In other words it gets you less long, ergo, less loss. (notwithstanding other Greeks)