Opinion for a strategy?

[quantuz]

One strategy that I've thought about is:

1. Sell at the money.
2. "Use" the money from the sale and buy deep out the money.

It's actually called "call back spread"...or a "put back spread".

The idea is as follows:

When you sell at the money one contract and buy deep-otm say 10 contracts...then a slight move up will make big profit. If the don't or go the other way...you still can pocket by the money left out of the call/put sale.

I see a few problems here though:

1. Implied volatility. It's not secret that out the money options have higher IV. But is this really a problem here?
2. Optimum time to exercise. You should close all your positions before experition...and you will be tempted to hold them more and more.
3. Commissions. Commissions are a big problem here. I guess direct trading to cboe or trading via interactive brokers can offer better results.
4. Low delta of otm options...
5. I guess not a good idea to be used in fx options. cfd options (is there such a thing?) or any otc based "against the house" gambling options.

Basically, if you calculate this strategy via black-scholes's fair prices - the potential profits turn to be a shocker. Like...50% per month . But again...these are the problems mentioned above. Finally...this is the assumption that both atm and otm options have roughly the same IV.

10x and happy new year.

 

[etem_tezcan]

Will analyze your strategy using AAPL option prices. it is at about 350, 2 month options IV %31, ATM call 20, 390 call 5.

You sell 350 ATM call, collect 20, buy 4 390 calls, spend 20. You are even money.

at expiration:
AAPL is 390. You are exercised 350 call, 390 calls worthless. You lose 40 pts = (390-350). this is worst situation.

AAPL is 405. You are exercised 350 call. You exercise 390 calls. You are nearly even. your profit is -(405-350)+ 4 x (405-390)

AAPL is 450. You are exercised 350 call. You exercise 4x 390 calls. your profit is -(450-350)+ 4 x (450-390)

AAPL is 340: all calls expire worthless, even:

As you can see, using a back spread is not a license to print money. you are losing money after ATM strike till beyond strike price of your long OTM calls.

If IV falls after you enter back spread, you are losing money. Since money you paid to OTM options has a greater IV portion in them compared to ATM short call and when IV falls, you are suddenly in red.

One should consider back spreads when IV is low and when you expect very big gains.