Hi
I guess, some of you know what legging in means when you trade option strategies.
I had lunch with some money managers and the discussion was about back spreads.
There have been different meanings about it and I wondering if you have any comments on that ?
(a) One guy tried to tell me with all his face, he only recommend that by high volatility.
An other one had a big compliance about that and was quit angry that some one could even say or teach such stuff. He told, that this strategy was only working with low volatility and all the rest would be to risky.
He explained it that way :
I will use the Call Backspread as an example. The strategy requires selling 2 calls just out the money, and buying 3 calls further OTM. You can do it with any ratio of short calls to long calls, but try and get a net credit for the position. It is best to get the short call positions first and then leg in with the long calls, because it is always easier to buy options than sell them. (b)
I was surprised by that answer !
I always bought the first leg and then I sold the next leg.
What is your meaning or experience about that ?
DanPickUp
In my view, both trader are right in their own position. that's what they have learnt, observed and developed as belief .. so who are we tell them that they are worng.
Regarding point (a) - we don't get high volatilty enviornment always. So if we wait for that, then almost 60 to 70% of the time, we will be waiting. Though Call BackSpread (CBS) has better return profile in High Vol environment but that should not restrict us from trading them in other mkt conditions.. And IMO, high vol/ low vol etc is relative term.
On point (b) - I try to execute both leg at the same time, if broker provide me quote for complete strategy then. If not then, try to build up the complete position with minimum possible gap between opening both legs. Wider the gap, more I am risking as slippage.. There is equal chance that market may get me better price (by moving favourable) or worse price (by moving aginst me).
To reduce the cost, it is better to built the position in two lots.. i.e first open Credit Call spread and later add 1:2 CBS to it.. which effectively gives u 2:3 CBS. By taking short leg first, we are always carrying the directional risk for some time. And once the directional move develops, quite demand for options of such options also go up which drives the prices up. so I am not sure, if someone will really get the better price when move has gone against them.
In my observation, when market is falling, Puts come in demand and they start getting costly just because of demand/supply equation. And ofcourse call starts getting cheaper. Professionals use this very well to take their position using right instrument thru synthetics.. but mojority of novice option trader don't realise it.. and they construct strategy with put in falling market and with calls in rising market.
Atleast that is what is my view on it..
