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I appreciate your position that you want a predetermined max loss, however
if you buy a deep in the money option, there is very little gamma or vega.
As a result the option price tends to get bid up such that the implied
volatility is disproportional to the level of vol of the market. This means
you are essentially paying a premium to use the option Vs a cash position
yet the risk-reward profile is the same therefore making it more difficult
to make money. Secondly options tend to have a proportionally wider bid
offer spread than the cash which also has a negative effect on your P&L.
The only scenario where I think this could be superior to trading the cash
with a stop loss is if the market explodes into an exceptionally volatile
phase and trades through what would be your stop loss before recovering and
trading back into the money. However, in this scenario you would in fact be
better having an ATM option as it has more gamma to trade and is in fact a
completely different strategy to a directional play.
Anyway each person needs to trade the way they feel comfortable, but from a
purist point of view this is an inefficient way to use the product (i.e. an
option) and makes harder to make money.
Bank of America
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Peter2150 @ aol.com
05/01/98 09:28 EST
Please respond to Peter2150@xxxxxxx
To: realtraders @ listserver.com
cc: (bcc: Killian Smith)
Subject: Re: Stocks vs Commodities
Classification: Internal Use Only
In a message dated 98-01-05 04:34:43 EST, Killian.Smith@xxxxxxxxxxxxxxx
writes:
> If you trade deep in the money options, your risk profile essentially
> mirors a cash position. Is this what you want and if so why use options
?
>
Two Reasons. Leverage, and absolute risk. If the stock was taken out and
shot(CNBC terminalogy), option position limits absolute loss. Same thing
on
a short position, where the stock took off and ran to the moon.
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