One of the appealing features of options is that we can use them to create positions that reflect specific views of the underlying market. If we were limited to trading the underlying we could only express straightforward views such as being bullish (buying the underlying) or bearish (shorting the underlying). With options we can do much more. In this chapter we see how to do this.
When looking for an options strategy, there are three main things to consider:
1. Our forecast of the direction of the underlying.
2. Our forecast of the volatility of the underlying.
3. The amount of risk we are willing to take.
These are not the only considerations. As we have seen, option values also depend on interest rates and dividends, so these should also be considered. However these will generally be of far less importance than the three factors listed so can be taken into account last.
FORECASTING AND STRATEGY SELECTION
Bullish Underlying Forecast
If we are bullish we expect the underlying to rise. In this case we want to select an option strategy that profits when the market rises. So these strategies need to be long delta.
Bearish Underlying Forecast
If we are bearish we expect the underlying to fall. In this case we want to select an option strategy that profits when the market declines. So these strategies need to be short delta.
Neutral Underlying Forecast
In this case we either expect the underlying to remain in a tight range or we could have no opinion ...