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Minyan Mailbag: Puts vs. Shorts for Short-Term Trades

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When folks are tripping over themselves to buy options, it's usually a decent time to feed the ducks.

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Todd,

Reasonably new Minyan and full-time trader here.

I have not had much luck using puts myself for short term trades on anything other than, for example, SPY or QQQQ, where the spreads are typically very small (pennies), just because of the cost of the spread. Even a small move in your direction turns into a loss. I've instead been shorting stocks/ETFs, which has worked out much better. For medium term (over a week), options have worked out fine.

Care to share any thoughts on this? Do you use a particular time frame or amount in/out of the money when making these types of trades in order to reduce this effect? Or is it just the cost of making these trades?

Thanks.
-Pete


Minyan Pete,

It's really a function of preference and time horizon. You are correct in that there is a fairly big "vig" on the options market and, for short-term trades with tight stop losses, the underlying is typically more efficient. I have historically operated using a "mixed blend" and that ratio is a function of several variables.

For instance, with vols at current levels, I'm inclined to be "long gamma" (long options), which affords me the opportunity to "trade around" the position via stock. There are times, when vols expand, that warrant shorting options. The rub, for lack of a better word, is that when folks are tripping over themselves to buy options, it's usually a decent time to feed the ducks.

We've seen a lot of this: last week, when everyone and their sister was reaching for protection, for instance. We're now seeing the opposite---with the market higher, "hedges" are being dumped left and right. It's not an absolute formula (nothing is) but, rather, more of a rule of thumb.

Thanks!
Toddo
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