I’d like to use a leverage to help me build up an investment portfolio and I figure a call portfolio with a size cap is a reasonable way to do so. I’m at a point in my life where a 50% return makes about the same as minimum wage salary.
So as someone who knows nothing about options;
How did you take a strategy from p123 and use it to purchase calls? Did you learn about option pricing before hand or did you just buy calls deep on the money with low premiums?
My current idea is to take the average return of my strategies (around 1.25% per week) and buy the best option given that expected return. Is that a reasonable way of using p123 data and using it to purchase calls?
If you are completely green to options I would suggest you learn how options work first. Buying and selling options is much more complicated than buying stocks, although anyone can understand them. Without going into too much detail buying call options which is what I’d assume you would do is going to present a whole other dimension of complexity, specifically because you now have to manage strike prices and expirations which are priced by premiums. So now the question is not only about whether a stock is priced cheaply but which option strike and expiration offers the best outcome based on the current premium. To get an option to act more like a leveraged purchase of a stock you really want to buy deep in the money calls where the strike price is much lower than the current stock price. There are some constraints with options as well - you have to buy contracts representing stock in multiples of 100 and liquidity of options on stocks tends to be thinner than that on the stocks themselves. Anyways hopefully my comments have stirred some thought or questions. I’ve only provided a quick summary. There are plenty of resources out on the web to begin to learn options trading.
These are things I know, I actually read a textbook on option pricing to try to figure out pragmatic ways of doing this – the issue I’m having is that I turned 1,000 into 13,000 in oct and back down to 500 with a strat thats done 15% and basically no drawdown using Dow Jones stocks over the same time period.
It’s infuriating and I’m totally at a loss. I was wondering if there’s something obvious I’m missing. To me it’s like, the typical option I’m buying will provide 10 to 20x leverage if the stock goes up 1% from its open.
Does that mean I should buy my options at open? Probably not; because they’re illiquid. On the other hand I could set a fair price assuming I want 20x leverage from expired at open, but this risks the market getting away from me.
Have you ever had to manage these sorts of real life, non theoretical challenges? What’d you do?
Do not trade options unless you have a forecast for future volatility and distribution of the security returns.
If you still want to trade options despite this advice, look at the bid / ask spread as a percentage of the mid price (fair value) and then figure out just how mispriced you think those securities are.
Then read about payment for order flow.
Your experience is true to life: you are likely to take huge risk and lose a fair bit of money the longer you engage in this activity.
Do not engage in this activity until you have a proper backtesting engine.
I tend to be more conservative in my investing so whenever I have boughten call options I have boughten in the money options where the delta is 80 or 90 to try limit the time decay/volatility skew. I did that play with gold ETF with good results in 2019 through early 2020 when gold was in an uptrend.
Higher leverage means higher risk/return. I think that’s what you experienced assuming you either bought at the money or out of the money call options. Seems to me like you want the huge gains without the downside which is inevitable with leverage no matter whether you do it with margin, futures, or options. As with any short term trading with leverage, risk management is more important than gains. There’s a few ways to approach in my opinion. You can choose to buy high levered options but keep most of your account in cash or make protective trades to hedge against large positions or buy deeper in the money options which maybe provide a lower level of leverage that feels more manageable. Of course you can try to day trade and manage your positions like a hawk which I don’t sense you want to do. I will say the benefit of deeper in the money options is that you still get some leverage but you don’t end up paying for as much time decay as an at the money option.
I have simulated options strategies on other platforms and in general buying at the money to slightly in the money or even deeper appear to yield the best returns with longer expirations doing better as well. Short expiration out of the money options seem to do the worst. I think this intuitively makes sense as well. Of course these are generalizations and a fast moving stock or market may yield better profit to loss ratios slightly out of the money.
I second Korr123. I should disclose that I backtested my Gold ETF option trades as well - not on this site, but with an options backtest engine whereby you could vary deltas and expirations. Even now I mostly stick to stocks.
Thanks so much for all your comments. After thinking about it, I réalisé now that I totally misjudged the character of the leverage of an option. Originally I was buying ITM calls within a week of expiry which would return 20% if the stock returned my projected average of 1.xx% per week.
I messed up when a call I owned fell out of the money after a 4% decrease. It makes total sense now, a call might be a reasonable speculation at the time of purchase, but only if the underlying acts exactly as planned.
The leverage increases as the price of the stock decreases and eventually reaches a point where there’s basically no chance of profit – whatever my original expectation was. This is all obvious, I just forgot? I’m such an idiot.
So if I want to do this properly I need a stop loss at the point where a contracts time value becomes way too high and a money management system to deal with inevitable drawdowns.
May I ask what engine you used to test options? I found optionstack quite clunky and would like to take the advice and fully backtest my method, applied to calls.
On a side note, it’s kinda wild. I knew that the nature of an option changed as it’s moneyness changed – but I was so concerned with being logical, following my strats expectations and not taking a loss too early that I didnt /realize/ it until I spoke with you guys. I’m such an idiot.
I built my own engine. It’s doable and not that much work: did it myself. Took a year and a half, part time. I’m talking from both theory and experience.
I know this stuff pretty intimately.
You view on leverage is somewhat an illusion. Yes, it exists, but no, it doesn’t change much but requiring you to be more certain about your forecast vs the market. There are things in the options market where you can secure cheaper implied leverage through derivatives (i.e. options) but that’s for pretty sophisticated traders.
I agree with the replies here. The only things I’d add are:
Consider selling OTM puts to generate income. Maybe 45 days to expiration, +/-. Not the same trade as calls, ie it won’t leverage your winners in the way you’re hoping, but I’m guessing you’ll have a higher win % as you’ll get time decay working for you, not against you.
If you are determined to buy calls, consider buying really long-dated maturities. Almost like LEAPS, something like 12-15 months. It’ll help if your model(s) identify stocks with low implied volatility, otherwise you might be paying for a lot of extrinsic value that will decay on you. In any event, buying calls with one week to expiration (or even two weeks) is typically a recipe for losing $$, imo.
If you want to learn options I highly recommend taking a course one of the best I have found is https://www.bigpicturetrading.com. The options master course covers everything you need to know. The site also provides a live daily update to many types of options trading and a simulator to help you understand your risk exposure. It’s not perfect (there is no forum like P123 but every question I have gets answered). I don’t follow exactly the recommendations I use my own models and apply the process to manage my risk. I also use Hoadley options to analyze my strategies and feed that data back into an options simulator I built to understand the metrics P123 offers. One thing I learned very quickly is leverage can really hurt you if you don’t fully understand it. Start small and do a year OS and you will have a good grasp of what options can do and not do.