if by chance you are thinking of trading off inside information, forget that thought. the SEC has very sophisticated methodology to detect unusual trading patterns.
What's the best option
- Thread starter Rich Tanenbaum
- Start date
This is true when sufficient capital can be hard to come by. If you have the account size, I'd own the common. I'd rather own 100k of common than 20k of ATM option that expire in 30 days (or any other combination option position.) Being damn sure of anything in the market is a fool's game. The market has a way of humbling you.
With that said, there are still times when it's preferable to put on an option position instead.
There's not enough information here. To effectively trade options, you must have a view of the probability distribution of the underlying within the given time period. A key element of the distribution is its kurtosis.
If your view of the distribution has a positive kurtosis (tighter range) relative to the kurtosis of the distribution implied by the option prices, selling puts makes more sense given your bullish view (negative gamma and vega). Conversely, if your distribution has a negative kurtosis (wider distribution), buying calls makes more sense to limit damage from moves towards the left tail while maximizing opportunity from moves towards the right tail (positive gamma and vega).
You have read different views - your question is very open ended. After all saying a stock will move a certain amount could be just the reason to open a straddle, strangle or Iron Condor. If you think it will go up a substantial amount a more bullish option set up would be good.
The rule I was taught is that if you are bullish and looking for a simple option trade you buy deep ITM options. The reason is simple, you have use of leverage and if you are wrong in your assessment the drop of the delta from 100 or 90 or whatever it was buffers your losses as the stock declines. This gives good results if you are right - of course others are right when they say an OTM option will yield a greater return but it is a far riskier proposition. Where an aggressive trader could justify having 5% of his portfolio in a deep ITM option - I think 5% in a deep OTM option is plain speculation.
When I buy an option with a long termer bullish view of a stock without having a precise idea of where it will go, I tend to buy longer term options (about 1 year or thereabouts a head). I then look at the ATM price for an option, add that amount to the strike and buy that strike. This relies on market efficiency which says that when I buy the general market believes by +1 year the stock will be at current price+ ATM option price.
The rule I was taught is that if you are bullish and looking for a simple option trade you buy deep ITM options. The reason is simple, you have use of leverage and if you are wrong in your assessment the drop of the delta from 100 or 90 or whatever it was buffers your losses as the stock declines. This gives good results if you are right - of course others are right when they say an OTM option will yield a greater return but it is a far riskier proposition. Where an aggressive trader could justify having 5% of his portfolio in a deep ITM option - I think 5% in a deep OTM option is plain speculation.
When I buy an option with a long termer bullish view of a stock without having a precise idea of where it will go, I tend to buy longer term options (about 1 year or thereabouts a head). I then look at the ATM price for an option, add that amount to the strike and buy that strike. This relies on market efficiency which says that when I buy the general market believes by +1 year the stock will be at current price+ ATM option price.
If you are wrong or only partially right you also lose with the passage of time (theta) and if the perception of the market is that the underlying is less likely to reach your target than when you put on the trade (Vega)
Deep ITM doesn't have so much theta - or was that your point?
I agree, but if you go so far ITM as to make theta almost negligible the price of that option will be high (almost all of it intrinsic) and will partially offset the leverage advantage (considering stock is usually margined at 50%). No free lunch in the markets.
If you have an actual statistical model that leads you to believe it is going to move in a direction you can code up a monte carlo for the option price pretty quickly. Then you'll have some rough idea of advantage and can make a bet. Depending on how good your model is you maybe back off on size (add some extra buffer into your pricing model).
Dont worry I always pay for my lunches - point is that deep ITM is like buying the shares at a discount and a 'safer' avenue than buying ATM or OTM. Its true the leverage effects is less but like you say there are benefits too.