I think the kite spread is a good idea, but a big gap, like the one I
highlighted, is still very damaging despite having the kite spread.
course trading smaller size will help, but that will result in smaller
I have another idea, not sure about its feasibility, but maybe you can
share some insights. How about buying a straddle at the end of the
session, then sell it back next day when market opens. Transaction fee
may be an issue here if I do this everyday, but let’s assume I only do
this when I think something big might happen, like earnings report.
1) Smaller size: The primary purpose of trading smaller size is to reduce risk. And it’s the easiest, most convenient risk management tool. too bad it’s used so infrequently.
In my opinion, ‘size’ is a crucial, risk-related decision that must be made for each trade. Of course, we already ‘know’ our preferred size, so unless some change is being considered, this decision is already known at the time the trade is initiated.
2) A ‘big gap’ is usually very profitable when you are the owner of naked long options. The only reason you may have a problem with it is that you are using one kite per 10 call spreads. That’s not really enough to provide a gap profit.
But is that your true goal? A profit from an unexpected, unlikely event? Wouldn’t it be more prudent to own a single kite as partial insurance?
These two figures show a 10-lot of call spreads protected by one, and then two kite spreads.
3) There are multiple problems with this play:
a) Daily commissions
b) Daily time decay: Yes, holding a trade overnight results in time decay for the options. See Adam Warner’s post for more on this.
c) Slippage. You may not have to pay offers and sell bids, but every time you trade, you give up some value to the mid-point of the bid/ask spreads.
d) If you think you have any idea when ‘something big’ will happen, then all you have to do is quit trading, take advantage of your ability to predict such an occurrence, and position yourself for an occasional windfall. That’s much easier than trading every day.
Earnings report? Are you kidding me? That’s when all the amateurs pay inflated prices for options. That’s the time you don’t want to be buying options. See this post.
e) If you don’t do it every day, you will surely miss the terrorist attack, or the assassination, or the massive earthquake and tsunami that has a huge economic effect. You will miss the out-of-the-blue discovery of a cancer cure. In short, you know you cannot time the market, and more than that, the gap producing events are unexpected. By definition you have no clue when one may occur.