Readers' questions about what options strategy to employ usually take two forms; the first asks what will deliver the best returns for a given scenario:
Suppose I come to the conclusion that a certain stock or commodity will betrading at least 20% higher during, say, the next six months than it is now. Ilook up the option chain and see manydifferent call strikes offered that expire six or more months from now. Isthere a theory that will help me make a rationaldecision on which expiration/strike is the best? Up until now I have been going for the cheapest, mostout-of-the-money one. That probably isn't the best strategy. Many thanks again. R.R.or people looking for alternatives to a suggested position:
Steve, How about selling puts, let's say February '04 of 320 and buy February '04 375 and finance the call. Thanks, R.B., referring toOnce I'm over the initial shock that someone would consider an alternative to my suggestions, I realize these great questions bring together many of the concepts discussed in previous columns. Seriously, this is a good time to emphasize that any recommendation is just one of many ways to skin a (insert your animal here). One of the primary attractions of using options as a trading or investment tool is the flexibility they provide, essentially allowing you to create a customized position that jibes with your specific situation or prediction; there is no one right "answer." Unlike going long or short the underlying, whose success is measured in the single dimension of buy low/sell high, option positions have a multiple of inputs, such as time and volatility, which create a much more dynamic strategy.
last week's column on gold and the suggested calendar spread.
How Long Are You?Remember the columns on the what and how of delta? Let's compare what happens to the two different positions of delta given hypothetical price points of gold in 30 days and the impact on equity.
|Feb. 375 Calendar vs. Feb. 320/375 Synthetic |
|Gold Price on 6/30/03||Feb. 375 Calendar Delta||Feb. 320/375 SyntheticDelta|
|Source: TSC Research|
Note that while the synthetic long delta remains fairly constant (meaning your profit and loss will essentially track the price of gold), the calendar spread becomes more bullish (a higher delta) as the price of the underlying falls and more bearish (the delta actually turns negative) as gold prices rise.
They're different positions, one is no better than the other. It may take time but finding the position that matches your anticipated scenario will be worth the effort. Regarding the first reader's question, if XYZ is trading at $50 and you expect it to rise to $60, you probably don't want to buy a call with a strike any higher than the anticipated 20% move. Any strike above $60 will presumably still be out of the money and therefore worthless come expiration. This doesn't mean you won't have the opportunity during the next six months to reap a profit from out-of the-money calls. As a segue to last week's subject of