For example, if you buy a stock, selling an out-of-the-money (OTM) call can reduce the stock’s cost. So, rather than try to pick the exact time when the stock might rally or drop, or vol might increase or decrease, you could enter a trade now, but layer a short option or option spread on top of it to collect a credit and reduce its effective cost if the event you’re hoping for doesn’t happen. But as they say, you have to be at the table when dinner is served. POSSIBLE STRATEGY: a long back-month strangle with a long front-month butterfly overlay. When vol is low, and you believe a breakout is imminent, but you don’t know which direction. Take note of how overlaying strategies can be combined so that one offsets, or reduces, the risk of another speculation, with each position having a specific purpose.ġ. Market makers manage positions by overlaying strategies-layers of options from their daily buying and selling activity. Can you have the best of both worlds? Know Your Options In a word, there’s often a short-term, and longer-term, view. Then, you might add other simple strategies over time to either reduce risk or possibly realize a profit, while still maintaining the basic speculative strategy. Positions for seasoned traders can grow over time-organically, if you will-when the stock and volatility (“vol”) move up and down.Ĭonsider starting out with the simplest strategy that can be profitable if your underlying assumption actually happens. But they don’t necessarily start out that way. Yes, some positions are complex, with long and short options occurring at many strikes, and over many expirations. And that can take time away from finding new potential opportunities. Plus, how are you going to manage that trade relative to profit or loss? The more complex a strategy, the more work it can be. A strategy that starts out as an eight-legged monster may also have high execution and commission costs. Most seasoned traders-retail or professional-don’t pursue complexity for complexity’s sake. Who knows? Your nice little iron condor might turn into a fire-breathing titanium archaeopteryx. And you can always add one more call, or one more put, or one more spread to a strategy to generate more time decay, widen out breakeven points, or reduce risk. Even assuming a finite number of calls and puts, there’s still a lot of them.
But if you’re curious, you can dip into option pricing formulas, probability theory, or even option strategies that don’t yet have names. Sure, you can stick with covered calls and iron condors and perhaps lead a long, successful trading career. There’s always something new to learn in the options world.
BUTTERFLY OVERLAY HOW TO
How to overlay a long back-month vertical with a short front-month vertical.How to overlay a long back-month strangle with a long front-month butterfly.How to layer options strategies when you don’t know which direction price will move or when markets might fall.
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