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Guaranteed Winning Trading Strategies?

Free Rides

There is no option strategy that can be entered as a "sure thing" or guaranteed winner. However, there are trading strategies where if things work out, you can end up with long calls (or puts) that have had their entire cost covered. From that point on, you have a risk-free trade, or a free ride.

The following techniques show various ways that free rides are THEORETICALLY possible. Usually, several things must go just right in order to end up with a free ride, so just using these techniques is no guarantee of success.

Just reading about these techniques cannot show you all the pitfalls and problems. The biggest pitfall is that you need to get the timing of trades right, usually several times. Another pitfall is that stocks that you think are volatile within a range, all of a sudden start trending up or down, or stocks that you think are trending, all of a sudden stop. You would be wise to paper-trade these techniques to get a feel for all the things that can go wrong.

Here we will just cover some techniques using calls or in some cases both calls and puts. You can use the same techniques with puts if you have the opposite outlook. For instance, Long Put instead of Long Call, Bear Put instead of Bull Call, etc.

Long Calls #1

If you are very bullish on a stock, you might buy two calls. If the stock rises before expiration to where you can sell one call at the price you paid for both calls, you have a free ride on the remaining call. Be sure to read the Option Buying Strategies page for some of the problems with this technique.

Long Calls #2

Another way to own a position "for free" is to buy an ATM Long Call. If and when the stock rises enough, you may be able to sell the next higher strike call for at least what you paid for the lower strike. This makes a Bull Call that cannot lose. Selling the higher strike call will limit potential gains, however, just like any bull call.

Bull Call

The Bull Call can be used to anchor trading in a stock you expect to be volatile above the long strike. After entering the position, you could take gains on the short calls whenever there is a volatile day to the downside, and sell calls again whenever there is a volatile day to the upside. Every gain taken on short call buybacks reduces your cost by the amount of the gain. It may take three or four successful volatile moves before options expiration, but it is possible to end up with a long call that has been completely paid for.

Bull Call, Diagonal

The same idea as the previous technique, only you use a long ATM strike several months out, and trade near-term short OTM calls against it. The advantage is you have more time to pay for the long call. The disadvantage is the long call costs more. If you do end up with a paid-for long call with a couple months to expiration, you can hold it or keep trading against it.

Calendar Calls

Calendar Calls can work the same way as the Bull Call examples if you expect the stock to be volatile above and below the strike price you use. If you use a long call with several months to expiration, the position has similar advantages and disadvantages to the Bull Call, Diagonal.

Double Diagonal

If you have a basically neutral outlook, and enter a double diagonal trade with near term short puts and calls, and longer term long puts and calls, you can theoretically trade short options "in the middle" every day. It would be much easier to try this strategy with index ETFs that have one-point strike prices, rather than a stock with strike prices 5 points apart. On down days, you would buy back the short calls and sell puts. On up days you would buy back the short puts and sell calls. You could conceivably end up with a long term no-risk Strangle. If you did use the very liquid stocks that have some one-point strike prices (such as CSCO or INTC) and targeted the possible no-risk strangle for an earnings date maybe three months away, you would be well prepared for earnings disappointments or surprises.

Ratio Diagonal Backspread

Here is an odd technique that could possibly result in TWO free calls. It is odd because you need to be neutral to bearish on the near term, and very bullish on the far term. But maybe that's not too odd - it is possible for a stock to drift downward when there is no news, and then spring to life when an earnings date or other announcement approaches. In this strategy, you start off with a small credit, so you could think of it as already being a free ride IF the stock does not go up before the first expiration. If the stock stays where it is until the first expiration, then you have TWO very speculative OTM long calls, paid in full. Notice that to get a credit on entry, the near term short call must have a little higher IV than the long term calls, otherwise the entry will be a debit. Also, using the position as shown, your broker's option matching algorithm will see that there is a short call with a strike $5 less than any long call, so there will be a $500 margin requirement on the position. Here is a graph:

Ratio Backspread Option Graph

The graph makes it look like the position would be a winner at any price on the check date, but that is not true. The green line is showing the entire position as if it had an IV of 33%. If the check line could show two different IVs as on the entry, it would not always show a gain, but would sag like the expiration line. (But if the IV on the short call did drop from 39% to 33%, the line is correct.)

 

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