Verticals as basic directional strategy

[mcjon3z 44]

I've been reading up on verticals as a lower risk method of playing a directional bias than outright puts and calls. Most of the articles out there are written from the standpoint of "Stock XYZ is priced at X and I think it will be at or above Y at Z number of days in the future." They indicate to set the long arm ATM and are calculating profit targets based upon holding the options to (or very close to) maturity. This seems counterintuitive to me for a number of reasons:

• You are guessing at a landing spot within a fixed amount of time and calculating risk/reward based on that
• ATM deltas are lower than marginally OTM deltas, but the deltas then drop off as you get further OTM. If you are wrong on the direction straight off the bat, deltas will be increasing and losses will compound faster than going further OTM
• Vega increases as you go further ATM, which would serve as a cushion in the event of a price drop and corresponding volatility increase (albeit very small)
• Tail risk as you get close to expiration

My thought is that in a purely directional play, you can buy cheaper spreads further OTM and set a stop/loss target based on premium paid at which point in time you re-evaluate and re-enter another trade. For example, if I think that QQQ has upside potential over the next 30 days and I want exposure to it:

• Buy spreads 2 months out with the intent of closing 1 month out (keeps your 30 day window and reduces tail risk)
• Choose OTM strikes at the point where deltas start decreasing so that upside movement increases price effect and downside movement decreases it
• Set target stop loss / gain points as a percentage of premium paid
• If you reach the 30 day window or your target stops, close the trade and re-evaluate; if it still looks good, re-enter at new strikes and expirations
• Lower prices = less total risk in the event of a meltdown that blows thru your stop loss point
• Higher delta further OTM = more potential return (or loss) on a dollar for dollar increase in the underlying, but we still have our stop losses and we have gone 1 month further out so that will lower the delta as compared to going 1 month out; overall delta on a 60 day OTM option will still be lower than a 30 day ATM option

Please shoot as many holes as you can into my thinking!