OPTIONS LESSON: How to choose Option Spread Trades?


Choosing the right options spread is important to earn profits.


A trader can initiate a neutral long strangle if he/she anticipate implied volatility will rise (without being bullish or bearish).


Likewise, traders can establish a neutral short strangle if they expect implied volatility will drop (without being bullish or bearish). Or, they may prefer to establish a near-to-the-money iron condor.


It is important that each trader choose the strategy that matches his/ her volatility outlook. Also they must ensure that the strategy is suitable for his/her risk tolerance and account size.


STRATEGY SUMMARIES


Each strategy is summarised below:


• Long strangle

–      Out-of-the-money (OTM) long call

-       OTM long put

-       Greek values = positive gamma, negative theta and positive Vega

• Short strangle

–      Out-of-the-money (OTM) short call

–      OTM short put

– Greek values =negative gamma, positive theta and negative Vega

• Strangle swap

–      Short strangle

–      Near -to-the-money long strangle in a deferred month

– Greek values =positive gamma, negative theta and positive Vega

• Iron condor

–      Near -to-the-money credit call spread

–      Near -to-the-money credit put spread

– Greek values =negative gamma, positive theta and negative Vega

What is the meaning of the GREEKS values?


• Positive gamma = position benefits from market movement (it gets delta long on rallies and delta short on declines)


• Negative gamma = position gets delta short on rallies and gets delta long on declines


• Positive theta = money earned per day from positive time decay


• Negative theta = money lost per day from negative time decay


• Positive Vega = money earned if implied volatility rises 1%


• Negative Vega = money lost if implied volatility drops 1%