So you've used DimeChimp tools to find some positions you want to be in ... what's next? There are numerous ways to put on a position or exploit market fluctuations. Let's detail a few of the most common.
Option Vertical Spread
A vertical spread consists of simultaneously buying and selling the same type of option with the same expiry and at different strikes. Vertical spreads are directional plays and useful when we expect the market to move a certain way. Why wouldn't we just trade a naked option instead? We certainly can, but spreading the options offsets some of the risk involved in naked option plays. Let's look at an example ...
If we see that stock XYZ is primed for an upward move, we can buy a call or sell a put. If we're right, the call will increase in value - where we'll be able to sell it for profit or exercise it and buy the stock at a lower price (the strike price), or the put will end up worthless and we'll keep the premium we received for selling it. But what happens if we're wrong? We could lose all of the premium we spent on our calls, or worse - the stock could plummet and we'd be hit with a big loss on the puts.
By trading a call vertical, we'd be selling a higher strike call to offset some of the premium we paid on our original call. The downside is that if stock goes too far upwards, the calls we sold would also end in-the-money and we'd cap our potential gain. What about the put vertical? To cap our downside risk of shorting the put, we'd buy a lower strike put. And the drawback? We lower the overall premium we would have collected if the stock does go up, or stays stationary until expiry.
To recap: verticals are directional plays which are great for mitigating risks and for knowing exactly what your max loss/gain can be on a trade. If you're bullish, you can buy a call spread OR sell a put spread whereas if you're bearish you can sell a call spread or buy a put spread. Using the asset's half-life is a great way of determining which option expiry to trade.
Buy-Write/Covered Calls
So your analysis points to a high probability of an asset going up, and consequently you buy it. You can still generate income even if the stock doesn't rally. A covered call entails owning an underlying asset and simultaneously selling ("writing") an upside call on the underlying. While this may sound counterintuitive, that call can provide potential income or soften the loss if you're incorrect about the underlying.
At option expiration, if the underlying hasn't ended above the strike price then you've collected the full premium of shorting the call. This can supplement any increase in value of your long underlying position, or offset some of the loss if the underlying has gone down. What's the downside? If the call expiries in-the-money you'll be assigned on the stock meaning that you're capping your potential gain. Covered calls are generally used by traders to generate consistent income on positions that they would already want to be long on.
Wheel
As a subsidiary to the buy-write, traders who want to own the stock before writing the call can sell a cash-secured put (CSP) in lieu of buying stock. As the name implies, you need enough cash on hand in case you're assigned and forced to buy the stock. If your analysis is telling you that a stock would be great to own at a certain price, selling a put with a strike at that price or lower would be good way to either generate income or acquire the stock.
If the stock ends below your strike at expiry, you'll be assigned on your put and will own the stock at your targeted price. Many traders will then sell a covered call on their position to continue their income generation. If the stock ends above your strike price, those puts will expire worthless and you'll keep the entire premium you sold them for.
0DTE Options (Zero Day-To-Expiration)
For traders with a greater risk appetite, 0DTE options might be interesting. As the name implies, these are options which expire on the current trading day. The most typical underlying 0DTE options are traded on are the major indices, as they are liquid in both underlying and options. While stocks typically don't have options which expire on every trading day, the most active stocks certainly have weekly expiring options, providing ample opportunity to trade.
0DTE options are risky in that their timeframes to expiry are so compressed. For buyers, premiums can evaporate quickly with no time to recover. The lure is that they can be used for massive amounts of leverage, with quick potential returns on orders of magnitude much greater than just owning stock. For this potential return, sellers will charge a much greater premium proportionally than options with longer times to expiry.
On the opposite side, sellers can find these prospects equally persuasive. Collecting quick premium and charging more for it can seem thoroughly compelling, and the vast majority of these options do expire out-of-the-money. Sellers risk being steamrolled and relinquishing all of their gains in one fell swoop.
Trading 0DTE options requires a greater, immediate conviction than other options. Traders can find this conviction in a multitude of places...some in price action, some in studying the news overnight, some in tea leaves. Our tools can provide a mathematical justification for that conviction, working in concert with all the other information tools that traders use to make decisions. Whether an underlying is over-bought/sold relative to another, or whether that underlying has moved where it typically reverts, or whether trading one strike versus any other provides the best value, DimeChimp has tools which can supplement your trading and help you make informed trading decisions on even the most risky plays.
Pairs Trading
The essence of pairs trading is to find and trade pairs of assets which are related, either through correlation or cointegration, such that the typical position of buying one and selling the other results in predictable price movements. While it is difficult to find single assets which move predictably in longer timeframes, certain assets are undoubtedly related and move in accordance with each other. A typical example is the S&P and Nasdaq indices. Its rare to have them move in opposite directions. By trading one versus the other, we mitigate a lot of the risk involved in trading single assets. One of the biggest factors is the overall market move or sentiment. If one crashes and we lose on it, those losses should be offset by gains in the other to some degree. Whether and when these two move such that their divergences/convergences are predictable or mathematically verified is another issue.
In pairs trading we try to capture edge by trading when the relationship diverges from what it is typically, in the expectation that the relationship will converge once again. It doesn't matter the overall move of the underlyings, only that one has moved higher or lower relative to the other's movement. This movement can be both positive or negative as expected when two assets are positively correlated, or possibly in opposite directions if we expect some combination of these products will result in a synthetic price which is stationary. Either way, we expect our resultant position/portfolio to behave in a certain way, and trade it when it doesn't. As a very basic example, if we expect the S&P and Nasdaq to move exactly the same, and the S&P is up 2% one day while the Nasdaq is up 3%, we might buy the S&P while also selling the Nasdaq in the expectation that that 1% gap will converge in the future, independent of whether either index moves up or down. As noted above, there are a multitude of ways to accomplish this position, be it trading ETFs (SPY/QQQ) or futures (ES/NQ) or trading combinations of options on any of the above.
