Dwight got me thinking… Low volatility plays Butterfly with Calls Butterfly with Puts Short Straddle High volatility plays Long straddle Medium Volatility plays (this is a stretch) Bull Call Spread Bear Call Spread Bear Put Spread Sound good?
What is a short straddle vs a long straddle? I dont think the CFAI notes differentiated between them. And as far as I know Bull and Bear spreads are directional strategies and do not pay off based on volatility.
dont straddles benefit from basically flat mkts, so I guess short youll simply re-coup the premiums of options sold, and hope it rerally doesnt move?
sv102307 Wrote: ------------------------------------------------------- > What is a short straddle vs a long straddle? I > dont think the CFAI notes differentiated between > them. Long straddle is long a call / long a put Short straddle is just selling a long straddle > And as far as I know Bull and Bear spreads are > directional strategies and do not pay off based on > volatility. That makes more sense. I knew it was a stretch.
How about this? Market Direction/Volatility Plays: *Market expected to go UP -low volatility: LONG covered call -high volatility: LONG bull call spread *Market expected to go DOWN -low volatility: LONG protective put -high volatility: LONG bear put spread/LONG bear call spread/LONG equity collar *Market expected to STAY THE SAME or DIRECTION UNKNOWN -low volatility: LONG butterfly spread with calls/LONG butterfly spread with puts/SHORT straddle -high volatility: LONG straddle/SHORT butterfly spread (calls or puts) *Arbitrage opportunity if prices are misaligned - box spread
Dwight Wrote: ------------------------------------------------------- > How about this? Much better. > > Market Direction/Volatility Plays: > > *Market expected to go UP > -low volatility: LONG covered call > -high volatility: LONG bull call spread > > > *Market expected to go DOWN > -low volatility: LONG protective put Why would you do this for low vol Dwight?^ > -high volatility: LONG bear put spread/LONG bear > call spread/LONG equity collar > > > *Market expected to STAY THE SAME or DIRECTION > UNKNOWN > -low volatility: LONG butterfly spread with > calls/LONG butterfly spread with puts/SHORT > straddle > -high volatility: LONG straddle/SHORT butterfly > spreads > > > *Arbitrage opportunity if prices are misaligned > - box spread
Excellent summary. Thanks Dwight and mwvt
I am not sure that I agree with the covered call/protective put classifications. Both these strategies you are using a call/put to protect your asset value. So you would do it if you think your asset price is in danger of decreasing. So they are independent of volatility in my opinion
mwvt9 Wrote: ------------------------------------------------------- > Dwight Wrote: > -------------------------------------------------- > > *Market expected to go DOWN > > -low volatility: LONG protective put > > Why would you do this for low vol Dwight?^ You picked the weakest of my strategies 
For this one I suppose you could put it under either low volatility or high volatility. The point is that you expect a downward movement of the market and want to protect against it, but you want to maintain your upside potential of the position. Payoff if the market dips then you exercise the option to sell at a higher price than the market.
sv102307 Wrote: ------------------------------------------------------- > I am not sure that I agree with the covered > call/protective put classifications. Both these > strategies you are using a call/put to protect > your asset value. So you would do it if you think > your asset price is in danger of decreasing. So > they are independent of volatility in my opinion Well I kind of agree with you and kind of don’t. I think volatility is an important assumption underlying these strategies. Covered call: buy/hold underlying then sell a call option on it with a higher strike price - The idea with a covered call is that you don’t expect the price of the security to move much, so you want to enhance your income by selling a call option on it. You win if the price rises slightly because you collect the option premium and can sell your asset at a higher price. Protective put: buy/hold the underlying and purchase a put on that asset to limit downside exposure - I agree this one doesn’t fit neatly into a category. Here you expect the price to rise over the long term but you want to be protected against short term losses.
protective put, cant you say its pretty much an insurance buy, maybe a risk averse strategy?
mwvt9 Wrote: ------------------------------------------------------- > Dwight got me thinking… > > Low volatility plays > Butterfly with Calls > Butterfly with Puts > Short Straddle > > High volatility plays > Long straddle > > Medium Volatility plays (this is a stretch) > Bull Call Spread > Bear Call Spread > Bear Put Spread > > Sound good? Or those the lyrics to some new wave song? I like the chorus the best.
I’m modifying this after looking at some payoff diagrams: Market Direction/Volatility Plays: *Market expected to go UP -low volatility: LONG bull call spread/LONG covered call/LONG equity collar -high volatility: LONG call option *Market expected to go DOWN -low volatility: LONG bear put spread/LONG bear call spread -high volatility: LONG put option *Market expected to STAY THE SAME or DIRECTION UNKNOWN -low volatility: LONG butterfly spread with calls/LONG butterfly spread with puts/SHORT straddle -high volatility: LONG straddle/SHORT butterfly spread (calls or puts) *Arbitrage opportunity if prices are misaligned - box spread
Dwight - REgarding the covered call I guess you are saying that we would not sell a covered call in a strong bull market. If yes I agree with you. But we could also sell a covered call in a bear market. The downside protection is not as strong as in a protective put, but we do not have to pay the premium upfront.
sv102307 Wrote: ------------------------------------------------------- > Dwight - REgarding the covered call I guess you > are saying that we would not sell a covered call > in a strong bull market. If yes I agree with you. > > > But we could also sell a covered call in a bear > market. The downside protection is not as strong > as in a protective put, but we do not have to pay > the premium upfront. I don’t think the covered call has any downside protection. If the stock goes to zero you lose everything except for the call premium. Covered call = long stock + short call
I agree not much of downside protection, but CFAI explicitly mentions that in case of bear markets you are cushioned by the call premium which is why I mentioned it.
covered calls definitely have downside protection—just not as much as protective puts. in bear markets, as vol spikes—calls could work better as you are getting so much for writing the option vs. buying very expensive puts. buy writes were a very common strategy in november/december for instance as the price you were getting for the call was so astronomical, your breakeven was extremely low.
Cool thanks guys. I’ll remember that point about the downside protection of the premium.