Option Strategy

[Newtron Bomb]

Ive been reading with interest the thread on options. I was interested some time ago in them and i have dabbled a little but not a great deal in fairness.

It got me thinking about an option strat that would be very limited risk with potential high rewards.

As it stands I look for patterns with good reward potential and trade this through futures. Set my stop in place got my entry and my target and away we go after a breakout. Simple... but what if it fails :?: whips :?: I said to myself, how many time have you seen it go the other way my the amount you thought that it would move but simply picked the wrong direction :?:

With option i could buy a put and a call at the same time both out-the-money so that all i would be risking would be the time value and ready to capture a move of an expected reasonable size in either direction over a time frame of 3/5 days. After a bit of reading this afternoon i found that this was called a combination

It seem to me that this is a vastly overlooked strat as it could yield consistant rewards.. after all i do this with futures so why would this not be successful with options :?:
Am I being naive to think its that simple :?:

 

[TBS]

Why buy a put and a call?

One of them will benefit from the move, the other deteriorate - perhaps not by the same amount - or possibly more depending on how far the market moves.

Even worse, the market could just sit there and look at you, losing time value, causing you to drop cash on both legs.

Why not buy the option only in the direction that you think that market is taking?

Options are great for taking relatively low risk, medium term views, but I don't understand why you would cut your profit by buying what you would consider to be an opposing view to the one that you have.

 

[Marc100]

Hedge!

Newtron Bomb...

It would be sensible to buy a call and a put especially if you expect a sharp move but feel unsure as to the direction.
You could use a straddle or strangle dependant on how big a move or how much risk your willing to take.

If you feel there is 70%-30% chance of your position being bullish then you could consider a Call Ratio Backspread .

Basic: Sell one lower strike call and buy two higher strike calls.

You definately have the right idea as one side of your trade is hedging the other.

All the best

Marc.

 

[RogerM]

This strategy is also known as a straddle and the pay-off diagram below shows its limitations. Based on actual figures for the ftse 100 May series, you could buy a put and a call at 3825 for £1380 and £1115 respectively. If the index refuses to move and is at 3825 at expiry (16 May) then you lose all the premium paid and you will have lost £2495 plus dealing costs.

Look at the heavy red line in the diagram below. As you can see , the index would have to be below 3575 or above 4075 at expiry for there to be any profit. If the index moves promptly, you could sell whichever option is on the wrong side of the move quickly to recoup some of the premium. At expiry, you are in loss at all levels between 3575 and 4025 - quite a range. If there is a big move, profit is potentially unlimited.

You could help pay for the long calls and puts by selling a call at 4025 and a put at 3625, bringing in £375 and £620 respectively,as shown by the blue line. This reduces the cost of the strategy by £995, and reduces maximum loss to £1500 if the index is at 3825 at expiry. The strategy goes into profit below 3675 and above 3975, but the cost is that the profit is limited to £500.

The risk/reward here is not good unless you are sure there is a big move coming. In that case I would prefer to wait until the direction is clearer and then put on a directional strategy - a synthetic or a spread perhaps. If I don't know which way the index is going to move, but I'm not expecting it to be large - range bound perhaps, i would consider a short strangle, as set out by TBS above (sell an OTM call above and an OTM Put below) and just keep the premium taken.

 

[Newtron Bomb]

Thanks for all your responses chaps.

When I wrote this thread it was just an idea that on the face of it (without putting any figures into it) it was a fairly risk averse strat. However, after putting some figures into it and some further reading it does seem to have its limitation and would be increasig the amount i had to risk by comparison to what i was doing already for the same reward. As you said marc 100 i could continue doing what am doin by looking for an expected move of a decent size and trade it with an option in the direction i think it will move instead of using futures.

This seems a more viable option if you'll pardon the put

 

[TBS]

Hi Roger,

Very smart options curve - your own or some available software?

 

[RogerM]

Hi TBS - This is the Hoadley Options model I keep banging on about. Runs in Excel 97 and above and completely free from :-

http://www.hoadley.net/options/LatestVersion.htm

Online tutorial at :-

http://www.hoadley.net/options/demos.asp

Full details on the other options thread:-

http://www.trade2win.co.uk/boards/showthread.php?s=&postid=26181#post26181

I find this freebie absolutely indispenible. Model the pay-off for any strategy you like, track the effect of time value decay, compare strategies, play "what if". I couldn't trade options without it.

 

[TBS]

Thanks Roger,

I'm in the throes of rewriting the TBS site, this kind of link is just what I'm looking for - personal use too!

 

[Mayfly]

Thanks for the links, Roger - excellent site.

Am I right in thinking that you were going to give a talk on the subject of Options and Options trading at some stage during the summer?

Cheers

SteveB

 

[RogerM]

Helen beat me into submission and I'm doing a 30 min slot on Index Options at the T2W traders day on 5th July.

 

[TBS]

hahahahaha, I shall think of you whilst I am cowering under an umbrella in Cornwall

 

[Helenqu]

Helen beat me into submission and I'm doing a 30 min slot on Index Options at the T2W traders day on 5th July.

I don't recall any beating being involved (Don't put people off!)

 

[RogerM]

2 falls and a submission as I recall! I'll do anything you ask, but please don't hit me any more.

 

[Robertral]

x

 

[Robertral]

Hi Roger,

Very smart options curve - your own or some available software?

Just use matlab or excell and put in the BS76 and create a portfolio that creates the strat. I.e long 1 call, long 1 put and plot against the variable you are intertested in i.e time, underlying price.
If you want a excell sheet jsut give me a shout