Why is simply buying an in-money-call and a lower strike price put near an event date a good low-risk high-reward strategy?

Question

My premise is that buying both an in-money-call and an lower strike price put near an event date, is perhaps, one of the better low-risk high-reward strategy.

Why? If the stock moves significantly higher or lower, the corresponding call/put has good upside potential.

If the stock moves higher, one could exercise the call option to acquire the stock at the options strike price and maintain the put so no new invested money is not at risk.

If the stock falls to the put strike, one could close out the position recovering some time value for both option trades.

The chief downside is that both stock options expire out-of-the-money (in a small price window) with an entire (but relatively small amount invested) loss of the associated premiums.

Major decisions are what stocks, thinking likely well correlated to the general market but not so risky so as the associated option pricing is not particularly expensive.

My citing an event date refers to a potential macro market event (like release of macro economic data, Federal Reserve decisions,..) or earning expected news for a particular company, where both risks may not be correctly priced into the option contracts.

Further advice welcomed.

Answer 1

My premise is that buying both an in-money-call and a lower strike price put near an event date, is perhaps, one of the better low-risk high-reward strategy.

This is not a low risk strategy. You're buying a strangle with one leg deep ITM so the cost is higher than a traditional out-of-the money strangle. Assuming that both legs are for the same expiration, your expiration breakeven prices are the put strike less the premium paid for both legs and the call strike plus that same premium. In addition, you have double sided theta decay since you're buying two options. And if buying near an event date, you'll be buying inflated options due to implied volatility expansion.

The ITM call has a much higher delta than the OTM put with a lower strike price than the long call. If the underlying drops, the put will be a poor hedge against loss.

If the stock moves higher, one could exercise the call option to acquire the stock at the options strike price and maintain the put so no new invested money is not at risk.

No. If the stock moves higher and you exercise the call to acquire the stock, you have even more money at risk now because your long put will be even further out-of-the money.

The chief downside is that both stock options expire out-of-the-money (in a small price window) with an entire (but relatively small amount invested) loss of the associated premiums.

The window of loss is much larger for your strangle. There is a fairly larger range of values where the call is in-the-money yet still loses.

Yes, in terms of total dollars at risk, buying options is less risky than buying the underlying but this option position is by no means low risk.

Answer 2

Unfortunately, your theory that there even is a low-risk high-reward strategy is flawed. There is no such a thing as a free lunch, and the efficient market hypothesis still applies. Generally, to have high reward, you have to take high risks. I think you'll find that any good option pricing equation will take efficient market into account.

If you have access to infinitely large borrowing facilities, it's possible to invent a strategy that would give you rewards with 99.9% certainty, but according to the efficient market hypothesis, this would mean with 0.1% certainty your losses would be massive.

An example for roulette (assuming no house edge here for simplicity):

• Make a 50/50 bet that gives you X dollars if you win, and loses X dollars if you lose
• If you just lost, repeat the bet by doubling X, and do a total of ten bets at most
• If you ever win, walk away with your profits

Let's analyze this

1. The first bet has 50% chance of winning.
2. If you lost X (50% chance), the second bet has 50% chance of giving you 2X so you might have X total profits
3. If you lose 3X from losing both (1) and (2), the third bet has 50% chance of giving you 4X so you might have X total profits
4. If you lose 7X from losing (1) .. (3), the fourth bet has 50% chance of giving you 8X so you might have X total profits
5. ...
6. ...
7. ...
8. ...
9. ...
10. If you lose 511X from losing (1) .. (9), the tenth bet has 50% chance of giving you 512X so you might have X total profits

If you win, you win X dollars. The probability of losing is 0.5^10 = 0.097656% -- rather small, isn't it? However, if you lose, you will lose 1023*X dollars.

The expected winnings is zero. You have 99.902% chance of winning, but you lose big if you lose.

With stocks unlike in roulette, your expected value is positive. But it's only positive if you (1) take risk and (2) are willing to tolerate that risk for a long amount of time. I'm sure if you invent some strategy that gives 99.9% chance of winning, the 0.1% chance of losing means you will lose so much money no sane bank would ever loan that to you.

You can't cheat probability theory. You can't cheat efficient markets. Well unless you have insider information, that is, or are doing something else illegal.