In the previous entry, we visited some of the basics of elementary strategies involving Calls, Puts and mostly Covered strategies. For a lot of folks who are new to Options this alone is sufficient to make a good amount of money with their existing portfolios. These are mostly people with investor mentality. This mentality is the most time-tested approach to making money from the stock markets. It takes a great deal of discipline and long term view on everything. Realistically, most of us can only aspire to be like Buffet, Bezos in terms of the long term strategies and achieve the ridiculous amounts of successes they have managed to achieve.

There are also enough number of success stories that have met their financial goals and more with a trader mentality. I am not going to endorse one over the other, since I am no authority on either of them. However, in this entry I will try to cover some of the strategies that are more trader-friendly i.e., the strategies here might appeal to the impatient and people who rely on making their livelihood from the markets on a monthly basis.

In this entry, we will start with covering strategies that involve Spreads. This is going to be a gentle introduction to Spreads and in the next entry we will cover Volatility Spreads.

Intro to Spreads:

What are Spreads:

“A spread is a strategy which involves taking simultaneous but opposing positions in differente instruments. A spread trader makes the assumption that there is an indentifiable price relationship between different instruments and although he may not know which direction the market will move, the price relationship between the instruments ought to remain relatively constant.” In a Long Call, you buy an option and hope the underlying goes up. In a Long Put, you buy an option and hope the underlying falls. But in both cases, the maximum risk is you lose 100% of the capital that you put into buying the options.

What are the different type of spreads:

Vertical Spreads

• Debit Spreads: There’s a statistic somewhere that shows that over 73.2% of debit spreads end up worthless. There’s another statistic that says over 98.7% agree that the previous statistic was a lie. This lets you buy options at a discount. By choosing, the right strike price you can really increase your chances of maximizing your profits. However, these profits are bounded by the difference in strike prices. If the underlying moves far enough to cross your farther strike then you are bounded this limit. However, if the underlying lies in the sweet spot between your strikes then you have best case. So choose your strikes carefully.
• Credit Spreads: There’s a statistic that.. In my experience, a majority of the books claim that this is a profitable way for most options traders to play in the market.

Greeks of Interest:

DELTA:

• Delta measures the sensitivity of an option’s theoretical value to a change in the price of the underlying asset. … As the stock price moves, delta will change as the option becomes further in- or out-of-the-money. (Ex: Velocity)

THETA:

• Option traders refer to the amount of loss in option value due to the passage of time as the option’s theta or time decay. The formal definition for Theta (time decay) is the rate at which an option position loses value or premium given the passage of one day, all other factors considered equal. (Ex: Decay rate)

GAMMA:

• The option’s gamma is a measure of the rate of change of its delta. The gamma of an option is expressed as a percentage and reflects the change in the delta in response to a one point movement of the underlying stock price. (Ex: Acceleration)

VEGA:

• The option’s vega is a measure of the impact of changes in the underlying volatility on the option price. Specifically, the vega of an option expresses the change in the price of the option for every 1% change in underlying implied volatility. (Ex: Excitability, Mercurial-ness)

Entry Criteria:

This is a very subjective topic. Each trader has his/her own preferences based on their risk appetite. Ex: Tastytrade started off with recommending a 16-DELTA for short strikes, then they came back with a research explaining how a 30-DELTA was no riskier than 16-DELTA because of the perceived inflation in DELTAs, impacted primarily by VEGA during seasonal options pricing.

Several books recommend sub-10 DELTA, I think it is especially useful for stuff like IRA accounts.

Exit Criteria

Decide on a profit/loss prior to placing the trade. Automate it, Trigger Limit Orders. They are not ideal, but work for most cases. Remove yourself from the picture as much as possible. Depending on your personality and choice of trading styles, you might choose to close a position within minutes from opening a position to several weeks or even wait for expiration. Either way, select an exit criteria that you know you will be comfortable with.