VERTICALS CAN GIVE YOU MORE BREATHING ROOM TO THINK ABOUT A TRADE. THEY SLOW THINGS DOWN A BIT, AND CAN REQUIRE LESS IMMEDIATE ATTENTION.
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money call and had the stock go up, and still lost
money as time passed (because of negative theta) and
volatility dropped (because of positive vega)? Yes, a
vertical still can have delta, theta, and vega, but the
poles are a little lower and closer together.
Going back to the earlier example, look at the
100/105 call vertical with the delta of 0.15 versus the
100 call with the delta of 0.60. If the stock drops 1.00,
the value of that call vertical would theoretically drop
$15 and the 100 call would drop $60. If the stock moves
against your position, the vertical can lose less money
than the single option. And if it’s losing less money,
you’re probably going to be less stressed, and better
able to figure out why the stock is dropping and what
you think the stock might do from here on out. Verticals can give you more breathing room to think about a
trade. They slow things down a bit, and can require
less immediate attention.
The main downside of verticals is that they have
larger commissions than single options (because there
are two options in the trade). But what really increases
commissions is that verticals don’t have much delta.
So, for example, in order to get the same risk exposure
as 100 shares of stock or some single options, you
might have to do many times the number of verticals. If
a vertical has a delta of 0.10, you’d need to do 10 verti-
cals to have the same delta risk as 100 shares of stock.
That would require the commission of 20 options.
THINGS TO THINK ABOUT
Now, while I still stand by my opinion that verticals
are the simplest options position, they are not suitable
for everyone. But if you are thinking about trading
verticals, here are three pointers I would offer up for
(1) Use limit orders. When you’re opening a position in
a vertical, consider using limit orders. They give you
control over the price where you trade the spread, but
there’s no guarantee that the order will be filled. Of
course, market orders will seek to fill your orders at the
next available prices, but you risk getting terrible fill
prices on two options, not just one, which compounds
( 2) Don’t “leg in” to the trade. Buying one option and
selling the other should be done with a single order.
When you try to do them in separate orders, it’s called
legging, and it exposes you to more risk if you only get
one “leg” order filled and the market moves against it
before you get the other side done.
( 3) Never set it and forget it. Even though verticals
might not be as sensitive, don’t just forget about them.
At expiration, be aware that if the stock price is in
between the strikes of the options, you could automatically exercise or be assigned on one of the options—not
both. That would leave you with a stock position after
expiration, and expose you to unwanted risk.
Verticals are the “gateway” trade. Once you figure
them out, you might combine them into more complex
trades such as butterflies and iron condors. Those
increase your trading flexibility and choices even more.
The information contained in this article is not
intended to be investment advice and is for illustrative
purposes only. Spreads, butterflies, iron condors, and
other multiple-leg option strategies can entail substantial transaction costs, including multiple commissions,
which may impact any potential return. Be sure to
understand all risks involved with each strategy,
including commission costs, before attempting to place
any trade. Be aware that assignment on short option
strategies discussed in this article could lead to
unwanted long or short positions on the underlying
security. Customers must consider all relevant risk factors, including their own personal financial situations,
before trading. Options involve risk and are not suitable for all investors. Supporting documentation for
any claims, comparisons, statistics, or other technical
data will be supplied upon request.