Directional trades

[Schopen]

I have been reading some options threads on this site. The consensus looks like doing lots of leveraged, single option directional trades isn't a long term winning strategy - and I was so proud of my options knowledge.

This implies that only volatility-related trades should really be considered, unless you're hedging something.

If single calls or puts are so well-priced, how is that spreading makes directional trades more feasible?

 

[Benton D Struckcheon]

I do directional trading with options, through spreads, because it defuses theta and vega, and defines the risk.
Buy an option outright, and you're asking to be killed by theta and changes in volatility. Spreads reduce that risk significantly.
If I buy a 47 put and sell a 45 put, I'm directionally saying I think it's going down. The sale of the 45 put:

1 - Decreases theta and vega (sensitivity to IV) risk significantly, making it more of a pure directional play,
2 - ...and defines the maximum risk as the difference in price between the 47 and 45 put, and the maximum reward as the difference in strikes between the 47 and 45 put, which automatically makes the reward much larger than the risk.

I compute stats on my systems for:

1 - Median, average, and frequency distribution of the time between buy and sell signals on every trade tested.
2 - Median, average and frequency distribution of changes in price on every trade tested.

...the first so I can define what expiration to choose, the second to figure out how much of a difference to put between the price of the bought and sold option in a spread.
(I'm still arguing with myself over whether to use the median, average, or the 80/20 rule to define these things. I'm still losing that argument. ) Spreads are good for if you have a system you trust on direction, but want to use options to limit your risk without having to worry too much about theta and vega bringing you down. Your deltas will be in the right direction, and you'll automatically be positive gamma, all of which is good.

 

[Schopen]

Awesome. Thx
Looks like a Bear Put Spread. See if I am getting my greeks right: Your long has to be nearer the money than your short, or you're shorting gamma..?

 

[Benton D Struckcheon]

Yep. Also, once the long side is in the money, take your profits on the whole thing, or at least take half off the table if you have done multiple spreads at the same strike/expiration. If price goes the wrong way after that, you'll lose very quickly on the long side (gamma, theta and vega are all at their peak for the long side when you're near the money, which will really do a number on you if you don't take your profits once you're in the money but still near the strike, and then the price starts moving against you). You have to be nimble.