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I am developing an algorithm and it needs to know what to do in certain market conditions

It takes on a Vertical Bull Call Debit Spread on LEAPS that are 12+ months out in the future. This means that a long OTM call is taken, and a short OTM call at a higher strike price is acquired as well. The net debit will usually be small, like .20 or .50 or 2.00 , this allows it to take on MANY contracts with very little capital

It gives only minuscule downside protection (to the entire position I mean, the entire position can take a loss quickly but it is nothing in compared to if you were only long that many contracts), but you also pick up theta decay from the short options if things don't move fast enough in your time frame

My problem is legging out, because it looks like too much leverage with my calculations.

The trading plan:

  • Buy long OTM calls, sell short further OTM calls

  • In the future, 6 months in, after some theta had some time to burn , if still bullish - close the short leg for 50-80% gain

  • Use the proceeds from closing the short leg to average down on the long leg (the long leg will be loss making but acquirable for much cheaper, this gives you control over a lot more contracts)

  • On the first uptick you make 50% gain (on the original principal used to open vertical position), on real bullish moves you make 4000% gains

  • If market direction turns against you, still max 100% loss on original position. Capped loss. May mitigate this with a stop loss, but stops may be too tight when you have 4 months to go.

The "problem" is how much leverage this appears to be. I am looking at 4000% to 10000% gain on original principle. Simple put, this many contracts would not have been affordable without collecting the premium from the short options. Yet the risk is still sound and limited to 100%, especially with any position sizing done in a larger portfolio. So I'm trying to find what I'm missing. This is a bullish strategy and it appears worthwhile to periodically buy small amounts of put protection because it will keep your losses near 0% when it is just a vertical.

I have my backtest going that shows everything I just described (which is really what makes me skeptical), so I would like the community to illuminate some things about verticals that I haven't already considered

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It works, I tested this using weeklies and the market whipsawed enough to get all the results I needed. You earn money for your time and use that earned money to buy more of your long at much cheaper prices, giving you much more leverage using less capital. The catch is that you have to be able to afford to leg-out of your short legs. You cant use the money tied up in the spread to buyback the short leg. The max risk becomes somewhere between 125%-150% of original principle risked.

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