Controversial Option Discussion Of The Day - Calls and Puts

[wayneL]

OK this is from the blog. In the real world traders might have more diverse reasons and goals for trading naked puts/covered calls, but as I say, it's intended as a thinking exercise involving synthetics.

Quote: We know that we can create a synthetic long stock position with options, by buying a call and selling a corresponding put, so we can look at any stock position as having a long call and short put embedded within it. We can then analyze the naked put option as a long stock position with the short call stripped out leaving only the short put. A covered call can be looked at precisely the same way, as you have long stock with the long call component stripped out, buy writing (selling) the call leaving only the short put, albeit synthetically. Why would an investor/trader do this? By implication, the investor is dodging the cost of buying unlimited upside (the call option premium) and electing to collect the premium available in the short put. He is implying that he doesn't believe the stock is going to appreciate in value more than the strike price, plus what the put option premium is going to deliver in the time to expiry. If he does believe the stock is going higher than that point, he is short changing himself. He also (by implication) doesn't believe the stock is going to fall by more than the strike price plus premium collected, otherwise just stay out, or use a different strategy. However if the stock does fall past this point, at least the loss is less than long stock. It is a bet that the stock price is going to stay in a range, and electing to collect premium rather than shoot for capital gain

[wayneL]

Quote: Originally Posted by mazzatelli1000 How about this timeless statement from a questionable character "Credit spreads are better than debit spreads because they...you guessed it bring in a credit to your account. Get paid first, ask questions later" True or False and why

[Ageo]

Quote: Originally Posted by wayneL BUMP. Because it's a great question.

[wayneL]

Quote: Originally Posted by Ageo Well for me the answer is true and thats because if your in credit it means you have a head start and something needs to go "against" you to lose. But a debit spread starts you off behind the ball with a debit and you need to have something go "for" you to gain. In short credit = at the front of the race and if nothing changes you win. In short debit = at the back of the race and something needs to happen for you to win.... Does this make sense or is it too late for me? Its like saying you buy a property thats positive geared from day 1 (credit) but buy a property thats negative geared from day 1 and your in (debit) the difference from the 2 is 1 is profitable from day 1 without any changes whereis the negative property needs a move in order to become profitable? (P.S this is just illustrating the differences between credit/debit trades and not strategy's). Please correct me if im wrong in anyway.

[Ageo]

Quote: Originally Posted by wayneL Ageo, I don't want to jump in too much on Mazza's question, but with a knowledge of the Greeks, you could analyze the put spread and the corresponding call spread with those Greeks (plus dividends and cost of carry/moneyness), to determine if the statement was true or false.

[mazzatelli1000]

Quote: Originally Posted by wayneL Yes good one Mazza. As a clarification, we're talking about identical strikes in the credit and debit spread, yes?

[Ageo]

Quote: Originally Posted by mazzatelli1000 Ooops Yes that was what I intended, I'll rephrase below Nah, its fine. I usually pull out too much verbatim to make any sense!! LOL Sorry guys, the question again: "Credit spreads are better than their debit spread equivalent because they...you guessed it bring in a credit to your account. Get paid first, ask questions later" E.g. a bull call spread vs. bull put spread with the same strikes

[wayneL]

Clue ==>> premium collection doesn't necessarily involve a credit.

[peter2]

Thanks for the question Mazzatelli (and WayneL). I had to hit the books again to try and understand. I'll try to explain.

Most people creating a credit trade think there are collecting premium if they see an immediate credit into their account. It is not this credit that defines the trade as a premium collection strategy. A credit trade may have nothing to do with premium collection. Premium collection is defined by the total theta of the trade. Theta or time decay is largest in the at-the-money options, so to collect premium one must be short (sell) the at-the-money option or the option (in the spread) that is closest to at-the-money.

Constructing an spread trade just for the initial credit is the wrong way to think about it, but I understand the lazy influence of greed. The vertical spread is a directional strategy but determining how best to construct your spread using calls or puts, that is another question for the experts. The better construction to trade your views of the future price movements could result in either a debit or a credit.

[mazzatelli1000]

Yes, peter2 is very warm that the premium capture in a vertical is affected by time/synthetic time [implied vol].

Quote: Originally Posted by cutz Personally i reckon credit spreads are better as they seem to have a higher probability of success. I say this because i think it's impossible to predict where a particular underlying is going to end up in say 4 weeks time.

[mazzatelli1000]

Quote: Originally Posted by peter2 Premium collection is defined by the total theta of the trade. Theta or time decay is largest in the at-the-money options, so to collect premium one must be short (sell) the at-the-money option or the option (in the spread) that is closest to at-the-money.

[investedz]

Quote: Originally Posted by mazzatelli1000 Since mention of credit spreads, the natural default is to assume the otm configuration where one is short premium - i.e. Time decay works for the spread. E.g. XYZ = 50 Bear call spread 55/60 If the stock falls, profit results. If the stock stays still, profit results. If the stock increases and stays below 55, it still wins. I imagine these are the reasons for cutz and Ageo responses, that something needs to go against you to lose. But consider the Bear put spread 55/60 [itm] If the stock falls, profit will result [deeper itm it goes] If the stock stays still, profit results [itm] If the stock increases and stays below 55, it also wins. [the gain on the 60 put > loss on short 55 put] This also needs something to go against you [i.e. large upward move like the otm credit equivalent], but it is a debit spread. The less time the better, just like the bear call spread. Is there a reason why the credit received still better?

[mazzatelli1000]

Quote: Originally Posted by wayneL Clue ==>> premium collection doesn't necessarily involve a credit.

[wayneL]

To add to Mazza's post, here's another handy thing to know. The Greeks Theta, Gamma and Vega are strike specific. That means that at a particular strike the above three Greeks will have a value that is irrespective of whether the option is a put or a call.

eg If the x strike gamma is y, the gamma for x strike call and the x strike put is the same, viz, both the call and the put gamma will be y.

That means that with vertical spreads, it does not matter whether it is a debit call vertical or the corresponding credit put vertical, theta (and gamma and vega) will be the same in each.

Though the individual values will be different, the sum of deltas will also be identical, because of the mathematical relationship between puts and calls.

[Ageo]

Wayne you ever done video tutorials on options?

Sometimes reading advanced options can be confusing like hell.

All good stuff thow

[mazzatelli1000]

An alternative credit spread:

ABC = $20

Bull put spread 25/30
- Short $30 put
- Long $25 put

ABC needs to move above $30 to be profitable!!

The synthetic alternative is the Bull Call spread 25/30
The short call [$30] is away from the money

Is the credit spread still good??

[cutz]

Have to agree with you there mazza,

Bull puts/Bear call credit spreads aren't better then equivalent debit spreads, but I’m still convinced appropriate credit spreads are the preferred option for trading options.

For example say a short butterfly, ABC = $35, IV ~ 20%, 30 calendar days out, 33/35/37. Looks more attractive than its opposite side, what do you reckon?

BTW, I haven’t tried this yet, still backspreading. ( I’m not even sure if technically I’m backspreading I just like holding more longs than shorts as a form of disaster prevention )

[mazzatelli1000]

Quote: Originally Posted by cutz For example say a short butterfly, ABC = $35, IV ~ 20%, 30 calendar days out, 33/35/37. Looks more attractive than its opposite side, what do you reckon?

[cutz]

Quote: Originally Posted by mazzatelli1000 LOL, why won't this question die!! It seems there is clouded judgement surrounding the synthetic equivalent when a credit is involved.

[wayneL]

Cutz,

There is really no inherently better/best strategy, only strategies that best suit your specific view... even if your view is specifically non-specific.

The short/long butterfly (do you mean the natural or iron?) question depends on your forward view of price movement and volatility... and what you are trying to achieve...oh, and management - if/how you intend to metamorphose the spread as necessary. Is the stock going to boogy in the next month, or sit there like a bank of faded geraniums?

Back to the vertical discussion and synthetics - there is a very good reason for considering synthetic equivalents:

1/ You want to pick the cheapest strategy in terms of contest risk, you want the spread with the tightest bid/ask and the least number of commissions.

2/ There may be assignment risks that are higher in one spread than the other, e.g. cost of carry issues and upcoming dividends. For instance, if you are DITM with a short call as one leg, and the stock is going ex-dividend, you are almost certain to be assigned early on that leg. Avoid.

So the credit spread may not be better or worse on the face of it, but specific factors in specific circumstances may make one better than the other in practice.

Quote: Originally Posted by Ageo Wayne you ever done video tutorials on options? Sometimes reading advanced options can be confusing like hell.