Options: Directional Trading

Question 1

What are the key uncertain variables behind an option’s value?

Answer 1

1. Underlying price
2. Volatility
   Hence a single position is a joint bet on two different risk factors.

Question 2

What is directional trading?

Answer 2

Technique used to take position on the underlying price of the option specifically. I.e. looking for a delta positive position with limited Vega (possibly close to 0)

Question 3

What is a way to build a Delta positive Vega neutral position?

Answer 3

To go long on a call and then short on a call with a lower delta (higher strike price). The strategy is known as a bull spread. Typical case if long ITM call and short OTM call. The resulting portfolio is Delta positive and Vega neutral.

Question 4

How do we create a Delta positive, Vega neutral portfolio with a put?

Answer 4

Short put with a higher Delta (in absolute value) hence higher strike, buy put with lower delta and lower price

Question 5

What is a bear spread?

Answer 5

A bear spread is the opposite of a bull spread, a strategy with a negative Delta and a neutral Vega. It is done when the trader thinks the price of the underlying will go down, but has no sure predictions on the volatility.

Question 6

What is a bull spread?

Answer 6

A strategy with a positive Delta and a neutral Vega. It is done when the trader thinks the price of the underlying will go up, but has no sure predictions on the volatility.