Vertical Spreads for Aggressive Growth
- Thread starter Cache Landing
- Start date
Well... It's now been about a month since my first trades in this journal. If all goes well, I HOPE to finish MAR positions off with an overall gain of about 3-5% after commiss. Considering the most I ever had at risk was about $2K, the return on risk would be around 20-25%. But I'm not concerned with return on risk because I don't intend to have 100% at risk frequently. On the other hand, $2K is not nearly committed enough, as I would've had to make 50% return on risk to reach the "satisfactory" goal of 10% overall.
I've definately had a few fluke positions that ran against me and made a few mistakes, but overall not too bad. Starting to rev things up a bit for APR and I am fully expecting to achieve 10% for the month. Things do go wrong, but that is the goal and I need to be confident.
I think that my biggest mistake for this month was my apprehension about making bullish plays as the market appeared to be rolling over. I've told myself in the past that with my style I definately prefer to be reactive rather than proactive. I don't wish to outguess the market by jumping into a trend before it is established. It is much easier to make adjustments in a balanced portfoio than it is to cosistently outguess the market and be loaded in one direction. I also need to remember that generally only 70% of all equities follow the trend. I need to make sure I find the companies that are not following and use them for balance.
This brings up my next thought. If the market is indeed going to change directions (not just now, but anytime), which plays (ITM, ATM, or OTM) are most suited to take advantage of the reversal? IOW, if the market appears overbought and fundamentals are becoming negative, It might be best to have fewer OTM bull put plays as they will be hurt the most by the reversal. Along the same vein, it would seem to be better to have more OTM bear calls as an overbought market is more likely to lose steam and not put the short strike in dangerous territory.
It could then be said that if an OTM spread is least suited for a situation then an ITM spread might be most suited as it would be damaged the least during a reversal. On the other hand, a reversal generally takes a little time to develope and one could be caught holding ITM positions with no chance for profitability. ATM positions might be easier to adjust. And, do I ever really need more than 70-80% return on a given position? Just thinking aloud. Thoughts are welcome.
I've definately had a few fluke positions that ran against me and made a few mistakes, but overall not too bad. Starting to rev things up a bit for APR and I am fully expecting to achieve 10% for the month. Things do go wrong, but that is the goal and I need to be confident.
I think that my biggest mistake for this month was my apprehension about making bullish plays as the market appeared to be rolling over. I've told myself in the past that with my style I definately prefer to be reactive rather than proactive. I don't wish to outguess the market by jumping into a trend before it is established. It is much easier to make adjustments in a balanced portfoio than it is to cosistently outguess the market and be loaded in one direction. I also need to remember that generally only 70% of all equities follow the trend. I need to make sure I find the companies that are not following and use them for balance.
This brings up my next thought. If the market is indeed going to change directions (not just now, but anytime), which plays (ITM, ATM, or OTM) are most suited to take advantage of the reversal? IOW, if the market appears overbought and fundamentals are becoming negative, It might be best to have fewer OTM bull put plays as they will be hurt the most by the reversal. Along the same vein, it would seem to be better to have more OTM bear calls as an overbought market is more likely to lose steam and not put the short strike in dangerous territory.
It could then be said that if an OTM spread is least suited for a situation then an ITM spread might be most suited as it would be damaged the least during a reversal. On the other hand, a reversal generally takes a little time to develope and one could be caught holding ITM positions with no chance for profitability. ATM positions might be easier to adjust. And, do I ever really need more than 70-80% return on a given position? Just thinking aloud. Thoughts are welcome.
Suggestion: to compare two positions draw the graph of the position resulting from subtracting one from the other.
As an example: compare the following two QQQQ spreads:
SP1: 1 long Apr 40 call & 1 short Apr 42 call
SP2: 2 long Apr 41 call & 2 short Apr 43 call
Draw the graph SP = SP1 - SP2:
SP: 1 long Apr 40 call & 2 short Apr 41 call & 1 short Apr 42 call & 2 long Apr 43 call
Where the SP graph is positive the SP1 performs better with that amount, and where it is negative the SP2 performs better with that amount.
Draw one SP graph for an IV 20-25% higher than current IV, and another one for an IV 20-25% lower. You'll observe how IV affects the comparison between SP1 and SP2. You may want to check other IV values too, like the one year range extremes.
Also, to see how an outlier would affect SP, draw the graph for at least a plus / minus three sigma price range.
As an example: compare the following two QQQQ spreads:
SP1: 1 long Apr 40 call & 1 short Apr 42 call
SP2: 2 long Apr 41 call & 2 short Apr 43 call
Draw the graph SP = SP1 - SP2:
SP: 1 long Apr 40 call & 2 short Apr 41 call & 1 short Apr 42 call & 2 long Apr 43 call
Where the SP graph is positive the SP1 performs better with that amount, and where it is negative the SP2 performs better with that amount.
Draw one SP graph for an IV 20-25% higher than current IV, and another one for an IV 20-25% lower. You'll observe how IV affects the comparison between SP1 and SP2. You may want to check other IV values too, like the one year range extremes.
Also, to see how an outlier would affect SP, draw the graph for at least a plus / minus three sigma price range.
Today's Action
BTC 2 RIMM MAR 60 puts @ 0.05
Year to Date P/L
Account Value: $10,269.00
YTD Gross P/L: 380.00
YTD Commiss: 111.00
YTD Net P/L: 269.00
YTD % P/L: 2.7%
RIMM announced a settlement today with NTP so their legal troubles are over. Stock is up $10/share. This triggered a BTC limit order that I had on the MAR 60 puts. It's almost certain that I could've held them until expiration and saved myself $3 in commiss. but I'd rather just get out now.
BTC 2 RIMM MAR 60 puts @ 0.05
Year to Date P/L
Account Value: $10,269.00
YTD Gross P/L: 380.00
YTD Commiss: 111.00
YTD Net P/L: 269.00
YTD % P/L: 2.7%
RIMM announced a settlement today with NTP so their legal troubles are over. Stock is up $10/share. This triggered a BTC limit order that I had on the MAR 60 puts. It's almost certain that I could've held them until expiration and saved myself $3 in commiss. but I'd rather just get out now.
I more or less do that exact thing when looking at potential plays. You're right, that will show at any given SET price which position would be more profitable. But I was thinking less about profitability and more about probability.
In order to answer the (rhetorical) question, I think one would have to consider the validity of TA. IOW, is there any merit to the concept of s/r. When comparing probability of profit for the graphs listed above we are making the assumption that price movement is random and more or less follows a normal distribution. Some would argue that a lognormal distribution is more accurate, but I will leave that debate to someone else. The question is whether the distribution is really normal. If it is in fact a normal (or lognormal) distribution then TA must be invalid because the price at expiration would be random.
I'm thinking aloud again, but it seems to me that for the most part we (retail traders) are forced to believe that TA has at least some merit. If we believe that price movement is random and option pricing is based on this random distribution, then options must be accurately priced and in your words, "expectancy is 0".
For those of us that think TA has some merit, we are forced to decide to what extent s/r is going to affect the normal distribution. This is difficult because we cannot assign it a numeric value or insert it into a black-sholes pricing model. If TA has merit, it could then be said, that an option priced using the black-sholes model is generally incorrectly priced because it assumes a normal (random) distribution. Thus it would be up to the individual to decide how incorrect that price is.
In any case, if TA has merit and we were approaching a reversal, the idea of structuring a portfolio to take advantage of that reversal seems beneficial. I don't generally fall into the category of a non-directional (delta neutral) trader. What I've been considering lately is whether it is more beneficial to balance your portfolio in such a way that you would profit the most, or get damaged the least by the reversal? Or are the two terms synonymous?
Firstly, I don't consider myself a pro 
Secondly, your "thinking aloud" has the disadvantage of being a little more difficult to follow.
Thirdly, considering the above two smilies:
-options' prices reflect the way the market factors in all the available information; you can notice that this translates in different IV (implied volatility) for different strikes and expirations
-TA (technical analysis) is a very wide domain and includes all the non-fundamental ways of forecasting price evolution, besides fundamental analysis (others may have other definitions for TA): this may be price, volume, indicators, trendlines, support / resistance, etc. (not including tea leaf reading and alike)
-delta (or any other greek, or greeks) neutral, still means that you have to forecast the remaining greeks, price and IV for each leg of your position for a well determined time frame (and this time frame is very important)
-any strategy / position that reduces the potential risk, reduces the potential profit too
-options (as well as futures) is a zero-sum game, while stock market is not (here too there are others who disagree); hence because of the wide slippage and commissions the retail options players have to overcome a handicap to be profitable (negative expectancy)
I have the feeling that these generalities may not answer your "thinking aloud". If so, please reformulate.
Secondly, your "thinking aloud" has the disadvantage of being a little more difficult to follow.
Thirdly, considering the above two smilies:
-options' prices reflect the way the market factors in all the available information; you can notice that this translates in different IV (implied volatility) for different strikes and expirations
-TA (technical analysis) is a very wide domain and includes all the non-fundamental ways of forecasting price evolution, besides fundamental analysis (others may have other definitions for TA): this may be price, volume, indicators, trendlines, support / resistance, etc. (not including tea leaf reading and alike)
-delta (or any other greek, or greeks) neutral, still means that you have to forecast the remaining greeks, price and IV for each leg of your position for a well determined time frame (and this time frame is very important)
-any strategy / position that reduces the potential risk, reduces the potential profit too
-options (as well as futures) is a zero-sum game, while stock market is not (here too there are others who disagree); hence because of the wide slippage and commissions the retail options players have to overcome a handicap to be profitable (negative expectancy)
I have the feeling that these generalities may not answer your "thinking aloud". If so, please reformulate.
Quote from cnms2:
Firstly, I don't consider myself a pro
Nor do I, but I have been trading options for a while, so I wouldn't call myself a newbie either. Is there some category that the rest of us fall into?
Secondly, your "thinking aloud" has the disadvantage of being a little more difficult to follow.
This is all too true.
Sorry about that.I would say that this statement is true. The majority opinion being the determining factor in the end.
Question:
If there are many lined up to buy a stock in relation to the number lined up to sell that stock, the price will go up as long as they aren't all holding firm to their limit orders. This can have a dramatic effect on the stock. Let's say that the underlying is stagnant, but there are many call buyers lined up in relation to put buyers (assuming at the same strike and expiry). Will the effect on the options be as dramatic?
I would say that it could be as dramatic. But it could be that options buyers are less likely to let the call price (IV) get too out of control in relation to the put price (or visa versa) if the underlying is not moving. Or are they more likely given the speculative nature of many options traders?
Overactive buying on one side (calls or puts) happens fairly frequently but I've never noticed the IV getting REALLY crazy.
Sorry, I should be more specific, and not use TA as a catch-all. But I do think that out of a very long list of items referred to as technical analysis, many are really talking about different parts of the same thing. For example, trendlines and support/resistance.
Very True!!
This is true, but not exactly what I was getting at. I can't think of a good way to explain what I was thinking about, so I'd probably better let it brew for a bit.
Essentially.....Options players have to be either much more skilled, or much luckier to come out ahead? Interesting concept.
Thanks for your input. I guess I feel that of all the threads that I can litter with my scattered thoughts, this would be the best one, so I don't ruin someone else's thread. Mostly I am looking for various opinions. It helps me in my brainstorming. I have a hard time just settling on something that seems to work without looking for better ways to trade. In any case, I'll try to keep the "thinking aloud" to a minimum from here on out.
Do you refer to the fair value equation?
strike + call = stock + put + interest - dividend
If this is violated, an arbitrage (free money) opportunity arises.
As long as you don't consider support/resistance to be only horizontal trendlines (as many do).
As a for instance: you're bullish, you buy a call instead of the underlying, you pay a premium, so the risk is smaller, but the profit is smaller too. You want to further reduce your risk by paying less premium, so you open a bull vertical, but you further limit your profit. Obviously all these affect your risk to each one of the greeks too. By selecting your strike and expiration, or even a different strategy altogether, you can build the reward / risk characteristic that fits best your needs.This is true, but not exactly what I was getting at. I can't think of a good way to explain what I was thinking about, so I'd probably better let it brew for a bit.
- -any strategy / position that reduces the potential risk, reduces the potential profit too
I didn't mean that. Options players just have some additional tools. They have to pay something for their use, and will pay even more dearly if they use them without understanding.
You should use any of the ET threads to ask questions, voice opinions, be right and wrong, take what you need (20%), ignore what's useless (80%). I was kidding about "thinking aloud". Everybody does it, in his own wayThanks for your input. I guess I feel that of all the threads that I can litter with my scattered thoughts, this would be the best one, so I don't ruin someone else's thread. Mostly I am looking for various opinions. It helps me in my brainstorming. I have a hard time just settling on something that seems to work without looking for better ways to trade. In any case, I'll try to keep the "thinking aloud" to a minimum from here on out.
Well put.
In regards to the fair value equation...
Given that an arb situation arises when one side of the equation gets out of whack, it could be assumed that arbitragures would immediately pull the price of the option back into balance.
This happening would prevent an option from gaining/losing too much value if the underlying doesn't move, if all else remains the same and the only thing affecting the change in price is an overwhelming number of buy orders. If that is the case, does the price of the option really take into account all of the available information? I guess it would if it derives its price from the underlying and the underlying made an adjustment to the available information (e.g. the expectation of bad news).
But, if the underlying has not yet reacted to the expectation, it is essentially impossible for the price of puts to go up without the price of calls rising with them. Both might rise because of an increase in IV, but neither can rise/fall independantly. Is that the consensus?
In regards to the fair value equation...
Given that an arb situation arises when one side of the equation gets out of whack, it could be assumed that arbitragures would immediately pull the price of the option back into balance.
This happening would prevent an option from gaining/losing too much value if the underlying doesn't move, if all else remains the same and the only thing affecting the change in price is an overwhelming number of buy orders. If that is the case, does the price of the option really take into account all of the available information? I guess it would if it derives its price from the underlying and the underlying made an adjustment to the available information (e.g. the expectation of bad news).
But, if the underlying has not yet reacted to the expectation, it is essentially impossible for the price of puts to go up without the price of calls rising with them. Both might rise because of an increase in IV, but neither can rise/fall independantly. Is that the consensus?