What am I missing?

J

jimmyjazz

OK, I'm rarely the smartest guy in the room, and that would definitely be the case if I were having lunch at the Quant Grille, but I'm not an idiot and I like math. I have some bona fides.

So here's the deal -- I have part of my portfolio dedicated to swing trading a system that performs pretty well, both in the real world and in back testing. Winning trades outnumber losers by roughly 3:1, and losers are about 60% larger than winners. Sharpe ratio is just under 1.8.

I tried to game the system by buying calls instead of buying the stock outright. I made sure I bought the same delta, and bought OTM calls to get that delta cheap. I paid no attention to anything else, although I did go out a couple of months to try to reduce my theta exposure, given that most of these trades close in 2 weeks or less.

My results have been all over the map. Doing a little digging, I see that my exposure to volatility is probably a culprit, and maybe some gamma, too, as well as theta. Anyway, I'm dialing back on my craziness before too much damage is done.

So here's what I like about long calls: quantifiable risk. The problem is the path I've been taking towards that maximum loss is unclear, and often a rapid sprint downhill.

Avoiding going long the stock at this point leaves me with a couple of other choices: a synthetic long, which seemingly has the same delta/gamma/vega/theta exposure but less capital expense up front, or perhaps get fancy by splitting the strikes on a synthetic long to provide some downside protection.

My question is this: say NEM is at $32.17.

-- I could buy 1000 NEM ($32,170) for a delta of 1000. Gamma/Vega/Theta would be zero.

-- I could buy 10 NEM Oct13 32 calls and sell 10 NEM Oct13 puts ($30 credit + margin) for same (synthetic) long, give or take.

-- I could buy 19 NEM Oct13 32 calls ($3,933) for a delta of 1007. Gamma (146) Vega (95) and Theta (-35) would be non-zero.

-- I could buy 15 NEM Oct13 32 calls and sell 15 NEM Oct13 27 puts ($2,310 + margin) for a delta of 1034. Gamma (54) Vega (29) and Theta (-9) would be non-zero.

-- I could buy 13 NEM Oct13 32 calls and sell 21 NEM Oct13 27 puts ($1578 + margin) for a delta of 1024. Gamma (14) Vega (1) and Theta (2) would be small, and time isn't bleeding me any more.


Am I looking at this the right way if my goal is to get exposure to positive movement in the NEM? It seems that the last scenario not only gives me downside protection but my Greeks are closer to zero and time is now on my side. What am I missing?

Thanks for any assistance.
 
One possibility is to buy DITM calls, with a delta close to one. They are a lot cheaper than stock and their exposure to the other greeks will be minimal. I do this frequently as a stock replacement, e.g. when hedging. Downsides are that they will be more expensive than ATM or OTM, you will lose a little on the bid-ask spread, and there is less liquidity.

To provide an example, looking at NEM October, a possibility might be the October 20 strike calls whose mid is 8 cents over spot, or the October 25 strike calls whose mid is 18 cents over spot. Not sure how much more you might have to give up to get a fill, but it might be worth exploring.
 
Thanks for the quick reply. Looking at your suggestion, I would go:

-- 11 NEM NEM Oct13 20 calls ($13,640) for a Delta of 1037. Gamma (12) Vega (16) and Theta (-12) would be non-zero.

Capital cost is higher, and time is against me. Isn't the split-strike Vega-neutral Theta-positive trade "better"?

EDIT: Oh, I see. It's a better long call that going OTM for cheap Delta. I'm trying to argue both sides of the coin. As long as I can back up the trade, I don't really care about capital cost. I think?
 
I personally would definitely go for the DITM call over the risk reversal. The risk reversal would give up the limited loss aspect that made you prefer the long calls over the stock. As an aside and not trying to state the obvious, but don't forget about the 9/3 ex-div on NEM.
 
without knowing it your taking a position on the implied volatiltiy of the option.. if your going to use options.. know your weapons... describing otm options as "cheap" , and using the word leverage gives me the impression you need to take a little deeper look.. . everyone always learns.. you can be right but still wrong with options..
 
Much obliged. I can completely buy into the notion that my definition of "cheap" is blind.

I'm a weird cat -- I get the math, it's the application of the math where my mind boggles. Calculus, DE's, PDE's, whatever, I ate them up in college and career. Now, looking at an options table full of numbers, my vision blurs!

I will take all this advice to heart, move back towards long stock or long calls, and re-read my options maths books.

Thanks again. Great, great forums here.
 
Oh, and on the topic of the example: I'm not trading NEM. I'm recently long there. It just had a less scary price than (say) SPY for the example.
 
Heh. Like I said, not the smartest guy in the room. I've probably patented and brought to market 1000X more than most guys around here, so I can live with that.
 
Quote from jimmyjazz:

Heh. Like I said, not the smartest guy in the room. I've probably patented and brought to market 1000X more than most guys around here, so I can live with that.
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I concur with buying of the DITM calls. Synthetically it's the same thing as buying 1000 shares of NEM and buying 10 Sept 20 puts for .10 or whatever they cost. So there is really no theta, it's just one for one with limited risk.

Here's the thing you need to understand if you are buying soft deltas in calls on stocks going higher. Volatility almost always drops when stocks rally. So you don't even need to model volatility, rest assured, it's going to drop. So soft deltas are going to kill you.

IF you absolutely have to buy soft deltas, the easiest solution is to buy an earnings month. So if NEM reports during the Oct exp cycle, buy your calls in Oct. They will hold a bid and vol will stay bid on the rallies. At least better then the non earnings months.
 
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