StockFetcher Forums · General Discussion · Deep in the money Options<< >>Post Follow-up
189 posts
msg #103321
Ignore fortyfour
11/12/2011 11:48:29 PM

Even with SP500 large cap stocks such as PG, GE etc.. the daily volume on the deep in the money nearest month options is very low...say 200 contracts for some of these.
My desire to use these options is a leveraged proxy for the stock ..approx .90-1.0 delta ,with virtually no gamma or vega.
I am not at all sure how troublesome it will be to exit these.
I have read that during these low activity ( 0 shares trading) times that market makers bid/ask is
determined by option pricing algorithms that maintain "parity" with the underlying stock.
Is this true?

It seems to be that the best way to exit these illiquid options may be a sell stop and giving up the spread on the ask( a dime or whatever it is at the time)....For me, this would be ok ( the cost of using these). Rather than chasing a limit order down...
and being charged for each changed order.

My question is bad can you be screwed on exiting these options? resonable parity to the underlying stock maintained?

I have also read that option market makers purchase directional neutrality so they can always provide liquidity.

I will find out on my own with small money but the experience of others... a voice of experience is always helpful. Thanks.

788 posts
msg #103324
Ignore gmg733
11/13/2011 9:04:55 AM

MM will go delta neutral to hedge risk. To them there is no long or short but rather where is the delta exposure and how to hedge it. They make their money on gamma rush. The more I learn the more I realize options trading is more about trading volatility than the underlying equity.

There are a hundred ways to trade options and they can all make you money. Always hedge yourself. Sell an upside call for some protection.

Lastly, do not trade low volatility and low OI options. You most likely will lose money.

189 posts
msg #103327
Ignore fortyfour
11/13/2011 4:36:29 PM

Indeed liquidity and open interest seem to be a detriment with deep in the money calls

MCD.... not to sexy...has been on a nice uptrend lately
The 90, 87.5 and 85 calls are deep in the money to various degrees.

It goes without saying you must be right on any directional bet.....and that is worth repeating..
MCD the underlying stock may not even be on a swing traders list due to its low volatility etc..
However , the in the money calls that I mention provide 10X to 15X leverage and are a reasonable
proxy for the stock as delta ranges from approx .8 to .95 among these calls with very low gamma and vega.
My method will be to use our typical oversold methods zscore16, rsi(2) etc and buy these calls
when it is actually the better time to sell the put( which I cant do) as IV will be crushed if a reversal occurrs.
The ATM will get a better bang if the move is large enough but, it may not be,..... to overcome the offsetting greeks
of the ATM..
Anyway, swing trading these deep in the moneys on SP500 stocks is something I am considering
but unfortunatalty the IO/volume aint good...switching to less deep in the money option is an option due to when
these go "too" deep in the money they really die.

Thanks for your input Gmg733 and please fell free to comment futher...thanks.

788 posts
msg #103349
Ignore gmg733
11/14/2011 10:17:20 PM

Stocks move 3 ways, up, down and sideways. Going long an option regardless of call or put from a rough stats perspective means you have a 33% chance of being right.

I do go long on small positions calls or puts. The reality is there has to be a lot of things go your way to actually make money. First of which is being consistently in the 33% on your trade.

I most trade the 66% of the trade. Yes, the opposite of what most of the crowd is doing. In stead of buying a call or buying a put where I really only leverage one greek or two if I am right, I sell spreads where I can be almost right about the move or dead on about the move and make money.

ATM options in theory (I won't get into this here) have the highest theta of any option in the chain. When doing long only options, I opt for at least 45 days, preferrably 60 minimum and I set a profit stop or trailing stop to take profits. I have had too many trade turn against me either due to vol crush or something else. So now I just take money off the table.

I also have had too many times when I was dead on right and the trade never made money. When you sell spreads or options, you increase your chances of being profitable. You won't get any 500% moves, but you can steadily and consistently milk the market.

If you day trade then naked long options can be great because you do not have to worry too much about theta and etc. But I do not day trade.

If I had to guess, this is what the big firms are doing. ;)

189 posts
msg #103361
Ignore fortyfour
11/15/2011 5:40:46 PM


Id like to throw this hypothetical( I dndnt take it) trade out there.....

Yesterday AAPL, very oversold in the bol bands,low zscore16, low rsi(2) etc....
Assume 10 contracts...commish about $10 with IB

Yesterday sell to open AAPL dec 375 put 12.63
buy to open AAPL dec 370 put 10.67
Credit of $196 per contract
Risk or ( 5 - 1.96) = $304 per contract.
Seems to me good risk reward ratio ?

AAPL Dec16 375 put yesterday was 12.63 today it is 8.40 down -4.13
AAPL Dec16 370 put yesterday was 10.67 today it is 7.05 down -3.62

Today buy to close 375 put for 8.40 (+ $413)
sell to close 370 put for 7.07( - $362) for a net of $51 per contract

10 contracts would be profit $510
Risk capital maintained in account is $304*10 = ($3040) until position closed.

At this time of day I cant compare yesterrday to todays greeks but would guess
IV (has to be underlying up....very good for option sellers)
Theta( low roc change at this time value of about .3 )
delta( yesterday probable around .35...maybe to high/risky on the
370 strike....maybe 365/360 better or lower?
gamma( low roc at this far out)
vega( about .40 cents on a 1% change in IV)

Anyway $510/$3040 or 16.7% return on capital seems good to me...of course this is a nice one.

I am reading Lee Lowells "Get Rich with Options" (terrible title...easy read) and he, like yourself is a big advocate of
selling options...His spread are deeper OTM with higher probability...less credit ....

Anyway, if you dont mind talking "shop" , as your posts are helpful, .....How might you deal/have dealt with this AAPL trade?

As of now the same AAPL 375/370 is 4.13-3.62 for a .51 credit... (5-.51) = 3.99*100 = $510/ $3999 or 12.75% max.
Much higher probability than yesterdays trade .

745 posts
msg #103362
Ignore maxreturn
11/15/2011 5:56:31 PM

gmg, I agree. Selling put spreads in an up trending market and call spreads in a down trending market isn't very glamorous and you won't hit any home runs. But it's a high probability strategy and can result in some very attractive gains over the longer term if you re-invest the profits.

788 posts
msg #103368
Ignore gmg733
11/16/2011 8:21:53 AM


You could have traded it like that. In my opinion, I don't like the short option delta on a spread to be above .30. In retrospect and the fact I'm a chicken, I would have most likely done a bear put spread STO the 370 and BTO the 365 in Dec. If I make half of my credit back within the first two weeks of the trade, I take it off. A lot of things can happen going into expiration week and I don't want to be hanging out trying to bring in an extra dime. Not worth the risk. Also, there is some support around the 370 level in AAPL, intermediate trend line and close to the 200MA.

Also, be careful what you sell spreads on. GOOG has a tendency to take out short options and then run the other way. Nothing worse than covering a spread to mitigate assignment and have it take off the opposite direction on Monday.

You seem to be getting the hang of it. Paper trade it till you get it right.

I will on occasion if the indicators for the weekly and daily are changing sell a spread a bit tighter on the delta. Just have a back up plan if it fails. :)

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