Option Spread strategy Analysis:

By combination in terms of calls and puts

1) Calls + puts
2) Calls
3) Puts

Above combinations will enable us to develop a wide variety of option strategies. These strategies can meet the needs of different market expectations and situations.
Every strategy has its own strengths and weakness. Some are expensive with low sensitivity to market movements. Some are very cheap but highly sensitive to markets. A strategy has to be devised depending upon market expectations and sound reasoning. Also never sit on losing position like a stubborn person. Markets have changed so it is better to cut the position by reducing loss. As famously John Maynard Keynes is reported to have said, "When the facts change, I change my mind. What do you do, sir?" So based on cost benefit analysis the position should be repaired or liquidated. Trading opportunities come every day. Only thing one can do is to stay solvent.
Option volatility trading is both art and science. For a particular situation there are multiple strategies that can serve the purpose. But option Greeks will tell more precisely which strategy fits the situation. Option strategies, Straddles, Verticals, Butterflies, Condors, Iron spreads, Box and synthetics have unique risk reward profiles. Each of these strategies is loaded with risk sensitivities uniquely. Some are high in Gamma and some are high in Vega.

A strategy should be created by considering a lot of factors. These factors include

1) Technical analysis of underlying
2) Historical and implied volatility analysis
3) Greek sensitivity analysis
4) Scenario analysis
5) Expected market reports
6) Mathematical analysis

Technical analysis of underlying: Technical analysis indicators, specifically, momentum indicators provide a view of overly sold or bought situations. Stochastic and MACD indicators serve this kind of purpose. Moving averages provide a bird’s eye view of market trends. Donchanian’s two trend lines provide a crossover system that provide the signal of buy and sell. Most importantly, all these indicators need to be analyzed along with volume and open interest.

Historical and implied volatility analysis: Implied volatility defined as market expectation of uncertainty in the market. This will help us develop range of underlying price movements like one, two and three standard deviations. Also this will help us to understand the probabilities of market movements. Most importantly, it can be compared with market experience of historical volatility to form a view about it. As volatility is mean reverting so this comparison helps in identifying this relationship.

Greek sensitivity analysis: Greeks are response of option value to movements in markets and time. Most important are, Delta, Vega, Gamma and theta. Greeks provide a way to look at various strategies that cost same. Two strategies can cost same but one has high Vega and other has high gamma. Depending on our view we select a trading strategy.

Scenario Analysis: For every trading strategy that is devised, scenario analysis is most important element. In this we get a clear perspective on the strategy with regards to what can happen if certain market conditions prevail. This will also shows us what we can loose or make in different conditions.

Expected market reports: Expected market reports will set the tone to the movements in the market. Economic indicator reports will define the path of the market movements. Unemployment report, Personal consumption expenditure reports and geopolitical events will drive the markets up or down.

Mathematical analysis: Markets behave mostly like herds. These herds are governed by certain loosely set rules. Quantitative analysis is used to understand these rules and implement strategies that can benefit.

Every Strategy should be viewed through these lenses. Then the strategy has to be executed.

Various kinds of option strategies can be devised for these market situations.

• High Volatility and Direction Neutral.
• High volatility and Direction Bullish.
• High volatility and Direction Bearish.
• Low Volatility and Direction Neutral.
• Low volatility and Direction Bullish.
• Low volatility and Direction Bearish.
• Sideway market with range bound volatility.