Option Strategy Bands

Richard Croft
February 11, 2013
4 minutes read

This Saturday is the first Option Education Day (OED) of 2013. The OED offers attendees an opportunity to learn basic and advanced strategies from option experts. Not to mention a great lunch, morning and afternoon snacks and an opportunity to meet with sponsors and test drive some excellent options trading platforms.

I have worked at OEDs since they began and for the last couple of years my presentations focused on where the markets are now and where they may be going. Bearing in mind that forecasting is more art than science.

This year along with that brief synopsis I will be introducing a new concept: Option Strategy Bands. The Option Strategy Bands are all about risk management in that they attempt to guide you to an appropriate option strategy taking into account your view about the underlying stock balanced against mean reversion and efficient market theory!

I have long advocated the importance of strategy selection while recognizing the challenges of tying strategy selection to market views. And the more I talk with day traders and other short-term investors I have concluded that managing risk through strategy selection is an essential requirement for successful trading.

When you think about it, short-term trades are usually motivated by emotions… greed inspiring optimism fear sparking pessimism! The very definition of short term refutes fundamental analysis in that it relies almost entirely on the ebb and flow of market momentum. One is attempting to profit from market noise that over short periods can push a stock’s price above or below some variant of intrinsic value.

The Option Strategy Bands augment one’s short-term market view by trying to soften unintended risks though appropriate strategy selection. For example if you are bullish about the prospects for the underlying stock, should you buy calls, sell covered calls or use a spread?

I have talked about this at previous OEDs and set out a basic solution that tied strategy selection to ones view about volatility. This series of OEDs will take strategy selection to another level whereby we take the risk metrics that determine an option’s price and tie it back to the stock’s current price relative to some version of intrinsic value. The objective is to deliver all of this is a very simply graphical user interface.

To that end Option Strategy Bands are really a variant of the Bollinger Bands. The difference is that we are not using Bollinger Bands as a technical tool to predict the performance of the underlying security. Rather we are using the bands as a series of boundaries that suggest an optimum strategy given your view about the underlying stock or index.

I will draw on some of the original work published by the late Jim Yates in his book the Option Strategy Spectrum and introduce new metrics related to the individual investors’ short-term trading metrics. Look forward to seeing you in Toronto!

If you have the time I highly recommend Saturday’s OED. Best money you will ever spend on education!

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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