Author Topic: Option prices are too high... time to sell options?  (Read 5860 times)

MustacheAndaHalf

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Option prices are too high... time to sell options?
« on: December 18, 2020, 08:36:13 AM »
I already have call options in my portfolio, but recently I've had trouble adding any more.  The November surprise of two 95% effective vaccines pushed stocks and options way up - much closer to where they could end up in a recovery.

As more experienced options investors have told me on this forum, calls and puts need to be in equilibrium, otherwise there's a risk free trade available.  So when calls are too expensive, puts should also be too expensive.  Maybe I can flip my thesis around.

If I believe long-dated call options are valuable, because stocks will make huge gains in a recovery... that also means in a recovery, put options will gradually become worthless.  Instead of buying call options... I can sell put options.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #1 on: December 18, 2020, 08:46:48 AM »
To flush this out a bit more, I might look at Macy's trading at $10.72.  I think a 20% drop is unlikely, so maybe PUT options with a $9 strike might be worth selling.

Looking at each expiration date, under a month doesn't make much sense.
4 week options $.20 / $10.72 = 1.86% for 1 month
5 week options $.36 / $10.72 = 3.34% for 5 weeks, much better
6 week options $0.43 / $10.72 = 3.99% for 6 weeks
2 month options $0.46 / $10.72 = 4.27% for 8 weeks
https://finance.yahoo.com/quote/M/options?date=1611273600&p=M

For Macy's, selling 17% out of the money PUT options, Jan 22 2021 seems like the best expiration date.

Note the downside risk is considerable with PUT options.  If Macy's stock drops by 33% down to $7.18, those $9 options are worth $1.82 plus time value.  So you can invest $36 for 1 contract, and then pay up $182 for a -400% loss.  I imagine that's why this isn't long-term, ongoing strategy ...

bwall

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Re: Option prices are too high... time to sell options?
« Reply #2 on: December 18, 2020, 09:28:08 AM »
I think that your thesis has merit.

Just one caveat: be sure and pick a stock that will benefit properly. This is, of course, the tricky part.

For example, I am bearish on cruise ship companies (and airlines for that matter). When they sail (fly) again, their fleets will be smaller than pre-covid while their debts have increased tremendously in 2020. However, lots of people see it differently and just because a stock *shouldn't* go up doesn't mean it *won't*.

Macy's and all bricks and mortar retail might suffer post-covid from the migration to online shopping that occurred during covid. I'm not good at picking these trends, though. Just alerting you to possibilities.

YYK

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Re: Option prices are too high... time to sell options?
« Reply #3 on: December 18, 2020, 12:02:37 PM »
Basic question: how does one know if options are expensive? Do you compare say the price of a given option at a strike at the money to an option with the same amount of time left and also at the money an earlier date? Track the change in implied volatility or the VIX (assuming that higher IV and/or higher VIX mean higher prices)?

You can say stocks are "expensive" because the PE is A Big Number when the average PE is A Smaller Number but there seem to be too many variables involved in options pricing for it to be that simple.

ChpBstrd

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Re: Option prices are too high... time to sell options?
« Reply #4 on: December 18, 2020, 01:06:52 PM »
As you know, long calls are the complete opposite risk profile than short puts. The short puts have all the risk of the stock going to zero, minus premium received. If you see a parity arbitrage, its probably dividend related. I.e. the call is worth more when it can be exercised right on the ex-div date, thus avoiding all the market risk until then while still getting the dividend, at the cost of the dividend minus remaining time value. Similarity the put is affected by the loss of market value that usually occurs after a dividend. I used to do a lot of spreadsheet math about various option strategies to capture the fat payouts of mortgage REITs while holding a protective put, and usually ended up with a mid-single digit return and mid-single risk.

Id say options are medium-priced, based on todays VIX reading of 23. If VIX was 15 or 16 Id say double leverage on long calls. If it was 30 Id be tempted to sell puts. The downside of getting a good price on options is that high volatility times are usually buying opportunities and low volatility times are when the risk of a fall is greatest. For now, I see little reason to trade either, and Im BnHing.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #5 on: December 18, 2020, 11:51:03 PM »
I think that your thesis has merit.

Just one caveat: be sure and pick a stock that will benefit properly. This is, of course, the tricky part.
When I screened stocks, I compared debt/equity ratio of companies in the same industry.  I figure if companies start to go bankrupt, the companies with the most debt and least assets will go first.


For example, I am bearish on cruise ship companies (and airlines for that matter). When they sail (fly) again, their fleets will be smaller than pre-covid while their debts have increased tremendously in 2020. However, lots of people see it differently and just because a stock *shouldn't* go up doesn't mean it *won't*.
Carnival sold 18 ships that were responsible for 1% of it's revenues, according to an SEC filing by CCL.  I've heard the claim you made elsewhere - you're not alone in saying CCL has a steep drop in capacity, but I trust the SEC filing.

I agree increased debt loads are a serious problem, especially for airlines.  If all airlines have massive debts, they all need to have the same ticket prices / revenues to pay off debt and remain profitable.  If one airline breaks ranks and declares bankruptcy, that airline emerges with less debt - they can be more profitable at the same ticket prices, or they can lower ticket prices.  Other airlines will have to follow suit, and declare bankruptcy to remain competitive.  I've hopefully picked an airline stock with a lower debt/equity ratio, but it's still a risk - which is why I only invested in one passenger airline stock.



Macy's and all bricks and mortar retail might suffer post-covid from the migration to online shopping that occurred during covid. I'm not good at picking these trends, though. Just alerting you to possibilities.
Macy's will probably lose some business to Amazon, but I believe it's less than expected.  I have the sexist assumption Wall Street is mostly male, and can easily underestimate the value of trying things on in person.  Ordering lots of stuff and returning most of it is a good way to get banned by Amazon - they're not good at providing the service Macy's provides, of trying on clothes and shoes in person.

In 2020 I've seen a number of stocks jump up together, and drop together on Covid news.  So while I won't know the exact peak recovery for Macy's, I expect many other Covid stocks to recover together, and give me a strong signal.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #6 on: December 19, 2020, 12:12:40 AM »
Basic question: how does one know if options are expensive? Do you compare say the price of a given option at a strike at the money to an option with the same amount of time left and also at the money an earlier date? Track the change in implied volatility or the VIX (assuming that higher IV and/or higher VIX mean higher prices)?

You can say stocks are "expensive" because the PE is A Big Number when the average PE is A Smaller Number but there seem to be too many variables involved in options pricing for it to be that simple.
That's a good question, especially since I don't follow traditional volatility measures.  My goal is to have the same recovery profit as the underlying stock, but with leverage.  Macy's stock started the year around $16/share, so a recovery at best can reach that share price, from the current price of $10.43/share.

If I buy shares, $16 / $10.43 = +53% profit.  When I look at long-dated call options near the money, their best profit is actually worse than the stock.

Just in the money calls, at $10 strike (Jan 2023) cost $4.05/share, about 39% of the stock price.  Since it's 4% in the money ($0.43), that means the first 35% of gains go towards breaking even, towards reaching $14.05/share.  The profit kicks in after that, with a $1.95 gain to reach $16/sh.  $1.95 / $4.05 = +48% profit, which is worse than buying Macy's stock - in the complete recovery scenario.

Another approach is buying out of the money options.  In a full recovery, $15 calls will lose money.  And $12 calls break even at $15.32, for a +20% profit ... much more risk, but less reward that stocks.

Finally, there's deep in the money call options.  That means paying $6.55/sh for Jan 2023 options at a $5 strike price, which are already $5.43 in the money.  The break even is much better, at $5 + $6.55 = $11.55, which takes a gain of +11% to break even.  In a full $16/sh recovery, an additional $4.45 profit / $6.55 price = +68% profit.  Despite 1.6x leverage (that is delayed 11%, to break even), the profit is +68% versus +53%.

So that's my view of options right now.  The percentages get better the shorter the time horizon, but a shorter time horizon also means less time for the recovery.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #7 on: December 19, 2020, 12:27:45 AM »
As you know, long calls are the complete opposite risk profile than short puts. The short puts have all the risk of the stock going to zero, minus premium received. If you see a parity arbitrage, its probably dividend related. I.e. the call is worth more when it can be exercised right on the ex-div date, thus avoiding all the market risk until then while still getting the dividend, at the cost of the dividend minus remaining time value. Similarity the put is affected by the loss of market value that usually occurs after a dividend. I used to do a lot of spreadsheet math about various option strategies to capture the fat payouts of mortgage REITs while holding a protective put, and usually ended up with a mid-single digit return and mid-single risk.

Id say options are medium-priced, based on todays VIX reading of 23. If VIX was 15 or 16 Id say double leverage on long calls. If it was 30 Id be tempted to sell puts. The downside of getting a good price on options is that high volatility times are usually buying opportunities and low volatility times are when the risk of a fall is greatest. For now, I see little reason to trade either, and Im BnHing.
One clarification: I'm taking about "buying call options" and "selling put options".  The risk profile of call options is 100% loss if the stock drops below the strike price, or gains far above the stock gains.  Similarly, selling put options has the opposite profile.  At best, the stock goes up, and selling a put option was pure profit.  But if it drops, it gives a multiple of the drop to the option holder, and can cost large multiples of the drop in stock price to whoever sold the put option.

I didn't consider dividends, but I noticed implied volatility is near 100% on many of these call and put options.  That's probably reflecting the VIX level you mention.

My theory is that Macy's, CCL, and other stocks are recovering as vaccines roll out.  The people most at risk of dying from Covid will get vaccines first, so as we reach 10s of millions of vaccinations, the death rate from Covid should drop sharply.  I think that effort will be in full swing in Jan/Feb, but the second vaccination is given 3 weeks later, so maybe Feb/March.  At that point, Covid deaths should be dramatically lower, and another recovery should kick in.

I'm not sure when the point of maximum uncertainty will be.  If I sell put options during that time, the prices should be at a peak.  And if the options include the recovery, they should dramatically fall in price - giving me, the option seller, a good profit.

Many stocks are well into their recovery, so there's not much room left between their current prices and their recovery stock price.  Often, the cost of call options is a significant percentage of the recovery, making them less appealing.  The only alternative seems to be shorter expirations, which adds risk.

bwall

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Re: Option prices are too high... time to sell options?
« Reply #8 on: December 21, 2020, 05:45:49 AM »
For example, I am bearish on cruise ship companies (and airlines for that matter). When they sail (fly) again, their fleets will be smaller than pre-covid while their debts have increased tremendously in 2020. However, lots of people see it differently and just because a stock *shouldn't* go up doesn't mean it *won't*.
Carnival sold 18 ships that were responsible for 1% of it's revenues, according to an SEC filing by CCL.  I've heard the claim you made elsewhere - you're not alone in saying CCL has a steep drop in capacity, but I trust the SEC filing.

I agree increased debt loads are a serious problem, especially for airlines......

Abbreviation mine.

Do you mind if I outline the bear case for CCL?

This year it has increased it's long term debt by about $10 billion, paying out 12% interest annually.

On top of that, it has increased the share float by 25%.

Some of the ship sales/scrappage had been planned and others were pulled forward by a year or so, thus the low revenue generation. They have also sold other ships that had not been planned prior to COVID, as well as putting ships in 'long term lay up status', apparently not a basketball reference. :)  This article has good information for both bulls and bears : https://www.usatoday.com/story/travel/cruises/2020/07/25/carnival-other-cruise-lines-cutting-ships-fleets-amid-covid-19/5449857002/

So, based on those facts, the question is "Will CCL stock price return to the ex-ante status quo" or "What will the new normal look like for CCL?"

In 2019, CCL stock was at about $50. +/-, of course. A 25% dilution puts that at $37.50. Their net debt increase is 'only' $2 billion (so far they've only spent $2b of the $10b raised), but they've got to weather another quarter or two before sailing will return, so we can reasonably expect this to be another $2 billion (based on last quarter's losses). With CCL's market cap of $20b, we're looking at a loss equal to 10% of market cap. Large ships just can't be parked  I still haven't factored in their interest expense of approx. $1b/year for the cash raised earlier this year.

The next unknown is when sailing on cruise ships will return to pre-pandemic levels, or it if ever will. I presume, of course, that there will be no new outbreaks or other events on cruise ships. Will people want to do this like they did before? More? Less? Time will tell but I don't see it as a sure thing.

With all these factors I don't see how CCL can get a $30 handle any time soon.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #9 on: December 21, 2020, 07:24:09 AM »
I'm very interested in hearing facts that disprove my theory.

I found $1.5 billion in share offering/dilution on Nov 9, which was 7% of their market cap.  I don't see other share offerings, but their SEC filings are endless.  I'd be interested if there are others.
https://www.bloomberg.com/news/articles/2020-11-10/carnival-files-to-sell-more-shares-as-cruise-industry-on-hold

When I screened lots of stocks, I noted each stock's debt/equity ratio, where CCL stands at 1.35 now.  And price/book value, currently 1.21.  The numbers are less relevant than how they stack up against competitors - on the theory I don't want to own the first stock that goes bankrupt.
https://www.morningstar.com/stocks/xnys/ccl/financials

It looks like Norwegian Cruise Line (NCLH) is worse off, with a 2.68 debt/equity and 1.94 price/book.  If Norwegian starts to go under, I'd need to decide if it's time to sell off Carnival call options.

Checking cruise line demographics, it looks like one of my points is weaker than I thought.  I figured older people are the majority on cruises, but the median age is actually 50.  I thought the priority for Covid-19 vaccinations goes to those over age 70 who are most at risk of dying.  Once they're vaccinated, they might want to finally escape after being trapped inside.  But those over 70 make up only 1 in 7 cruise passengers, so it's fewer than I thought.  But still, 1 in 7 is better than the current 0 in 7 ... so maybe it will help earnings and the stock price.

bwall

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Re: Option prices are too high... time to sell options?
« Reply #10 on: December 21, 2020, 10:03:52 AM »
So, share offerings are really hard to find long afterwards, plus there are other forms of dilutions such as options grants to employees, etc. and buybacks. I generally look at the company's balance sheet online to get this info.

For CCL: in the quarters 8/31/2019/ to 11/30/2019 to 2/29/2020 there are about 685m share of common stock outstanding. Pretty stable, in fact. But, on 5/31/2020 common share count goes to 758m then up to 857m as of 8/31/2020.  857m minus 685m = 172m . 172m/685m = 25.11%

Same thing with the cash: On the balance sheet, their long term debt spiked $10b and their short term debt jumped $3b, while cash on hand only went up $7b, meaning, in effect, they've already spent about $6b (not $2b. as earlier stated). --If I'm looking at everything correctly. I encourage anyone to look at their balance sheet and correct me if I'm looking at it wrong.

Also, the latest quarterly report I can see on my online portal is from 8/31/3030. Just looked to see when the next quarterly report is..... CCL's quarterly report is due out today (?) at close of market and it's gonna be ugly, so all those debt figures above will be out of date in about 4 hours or so.

Price/book for me is tough to gauge for cruise ships. What's the wholesale value Carnival cruise ship with the signature whale tail exhaust? Scrap value, perhaps. CCL's last debt offering was for $3b, over 3 years, unsecured. Presumably, they've maxed out all the loan to value possible on their ships and plan to issue stock in three years to pay off the $3b. The hope is to issue shares at, say, $30, or $40 instead of the current price of $20 in order to retire the debt. Thus, pushing dilution off in to the future and reducing the resulting dilution. At the end of the day, though, you have a heavy lid on the stock price.
« Last Edit: December 21, 2020, 10:10:35 AM by bwall »

ChpBstrd

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Re: Option prices are too high... time to sell options?
« Reply #11 on: December 21, 2020, 01:16:48 PM »
With all these factors I don't see how CCL can get a $30 handle any time soon.

At the end of the day, though, you have a heavy lid on the stock price.

There's a Feb. 19 bear call spread at the 30 and 32.50 strikes that would yield $0.23 on $2.50 at risk per share, or 9.2% (55% annualized).


MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #12 on: December 22, 2020, 08:05:37 AM »
I see the 685M shares as of Feb 28 in the 2020q1 quarterly report (form 10-Q).  For Aug 31, I see 775M shares outstanding in the 2020q3 quarterly report:
https://sec.report/Document/0000815097-20-000101/pdfofform10q.pdf#page=29

Using that data, the 685M original shares were diluted to 775M shares.  So the shares from Feb 28 now represent 685 / 775 = 0.88258 of the company, or 88%.

Dilution turned 685M shares into 775M shares.  Since the diluted shares only appear in the later number, I think that's where the division as to take place.  Another example:
A company with $100 worth of stock adds another $25 of stock.  The original $100 is now 100 / 125 = 80% of the total shares outstanding.  It's not 25% dilution, but 20% dilution, which leaves the prior owners with 80%.

The 2019 low point was $41/share, compared to a high of $59/share.  I don't know when the peak occurs, but I'd guess somewhere in that range.  For my calculations, I typically take Jan 1 ($51/sh) or Feb 20 ($42.50) stock price as the pre-Covid level.

A recovery is a recovery in market cap: price x shares.  With more shares, you hit the same market cap with at a lower stock price.  Dilution to 88% of Feb 28 levels turns a $42.50/sh price into $37.50/sh ... and the $51/sh into $45/sh.

The Feb 20 stock price, less dilution would be $37.50/sh .. versus $20.32/sh now.  If the stock recovers to it's Feb 20 market cap, it will gain +85% from here.  Or if it's recovering to the Jan 1 stock price, that would be +120% from here.  In my view, the lid on gains is still very high.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #13 on: December 22, 2020, 08:14:08 AM »
There's a Feb. 19 bear call spread at the 30 and 32.50 strikes that would yield $0.23 on $2.50 at risk per share, or 9.2% (55% annualized).
This being a thread about options, I'm curious about the "bear call spread" you mentioned, so I looked it up:
https://www.investopedia.com/terms/b/bearcallspread.asp

The "bear" part seems to mean the strategy profits off a falling share price.  I think that means you sell $30/sh calls and then buy $32.50/sh calls (for protection?).  Since CCL fell 2.5% today, those calls are getting cheaper:

CCL call $30 strike (2021 Feb 19) last sold for $0.60/sh
CCL call $32.50 strike (2021 Feb 19) last sold for $0.42/sh

An option of 100 shares means selling the lower strike for $60, and then buying the higher strike for $42, leaving you $18 to cover any losses.  In the worst case, CCL rises above the higher strike price, which costs $250 vs $18 invested.  Worst case loss of almost 1300%?  I might be reading all this wrong - feel free to correct me.

specialkayme

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Re: Option prices are too high... time to sell options?
« Reply #14 on: December 22, 2020, 08:17:56 AM »
Instead of buying call options... I can sell put options.

If your question is: "is selling put options profitable?" I would say: "yes". But that has nothing to do with COVID. Or an individual stock. It also has little to do with IV rank. Numerous research has indicated that OTM puts are generally overpriced (a comprehensive series of backtests can be found here: https://spintwig.com/options-scorecard/), have the ability to outperform holding the underlying, at reduced risk. People fear downward moves disproportionately, and so think they'll occur at a greater percentage than they actually do. Sell the fear. The key is to understand the risk associated. Most people incorrectly view short puts as inherently "risky." I actually view them as less risky than long puts. And equally risky as covered calls.

If I buy a $5 ATM put on a $20 stock, the max I can lose is $5 (100% of my investment). But what's the probability that you'll lose 100% of your investment? For an ATM put, about 50%. And the probability you'll be profitable is about 20% (as the stock has to rise not only enough to end ITM, but enough to extend beyond the price of the put itself). If I sell a $5 ATM put, the max I can lose is $15 (If the stock goes to $0, I still keep the $5 premium, but have to pay the $20 stock price, for a $15 loss, or 300% of my investment). The probability that I'll be profitable is about 80% (as the stock needs to drop not only enough to finish ITM, but enough to pass the value of the put itself). But what's the probability that you'll lose 300% of your investment? For an ATM short term put, VERY small (although not zero). But it isn't a risk you don't know about. It's right there. It's risky if you don't have the ability to absorb the $15 loss. It's risky if your only plan is to hold it till the stock goes bust. If you only have $10 in your account, then yes, it's risky. A black swan event can come and destroy you. But if you're sitting on $100, it's different. Just like most things in the stock market, don't over extend yourself.

If I sell a $5 ATM covered call on a $20 stock, the max I can lose is still $15 (the stock goes to $0, but I get to keep the $5 premium). Still the same as my short put. And my max gain is $5 (assuming the stock goes through the roof, I keep my $5 only). Same as my short put. And the probabilities are about the same too. Except in a covered call, I MUST hold onto the $20 stock (and pay commissions to buy it). In a short put, I CAN hold the cash (or other securities as collateral), or a smaller percentage, and roll the dice the stock won't go to $0. Thinking it can't go to $0 is risky. Not the put itself.

I regularly sell puts on index funds. It's a profitable strategy. You just need to understand the risks, and have appropriate stops in place. At some point the bottom of the market will fall out. A 10% drop occurs on average every 11 months, and a 20% drop happens on average every 4 years. Put appropriate stops in place, and you'll be fine.

To flush this out a bit more, I might look at Macy's trading at $10.72.  I think a 20% drop is unlikely, so maybe PUT options with a $9 strike might be worth selling.

I think you're viewing this wrong. You're thinking in the form of dollars. You're viewing it as the stock is at $X, and a 20% drop is unlikely, so I'll look for a put at $Y. In the long run, you'll be taken to the cleaners thinking this way.

Instead, think in the form of probabilities in a standard deviation curve. That's the delta. Right now, a January 31 $9.5 M Put is selling for $0.59, with a -33 delta. That's one standard deviation move (roughly). Which means, roughly a 68% chance of winning 38 days from now. You're job is to think about whether those odds are too high, or too low. If you think it's closer to a 95% chance of winning, it's a great deal, sell the put. If you think it's closer to a 50% chance of winning, not so much. If it's too close for you, look at two standard deviations (the -5 delta, $7 Put selling for $0.08), roughly a 95% chance of winning 38 days from now. Those are the calculated (right or wrong) probabilities of an expected outcome, not what someone "thinks" might happen. It's how the market is valuing it, so it's how you should be too. Your job is to determine whether the market is valuing it incorrectly. Not what you think the stock will do.

But, those are the odds of where the put will be ON the 38th day. What are the odds that it will stay out of the money within the next 38 days? Much higher than 68%. So sell the put, and buy it back when you hit a certain percentage of gain, say 25-50%. It increases your probability of success from 68% to closer to 85-90% (over all, I don't know much about M).

Macy's will probably lose some business to Amazon, but I believe it's less than expected.

Honestly, that's a wild guess. No one knows. The impacts of COVID on our psychology will last much longer than the virus itself. How long, or in what ways, no one knows. There are so many variables when it comes to one stock. It isn't worth the gamble in my opinion. Personally, I don't sell short puts on individual stocks on speculative plays. I will sell short puts on individual stocks that I don't mind owning long term (usually aristocrat dividend stocks), that way if I'm right I make money on the put, but if I'm wrong I get to own a stock that I wouldn't mind owning anyway, but at a lower price than I was willing to pay for it originally. If you think the MARKET will go up, sell a put on an index (the prices are usually better anyway).

Macy's stock started the year around $16/share, so a recovery at best can reach that share price, from the current price of $10.43/share.

Recovery can mean many things for Macy's. They closed a ton of stores, and slashed thousands of jobs, and that was even before COVID. Maybe recovery for Macy's means getting back to where they were in February. But most likely, recovery for Macy's means getting to where Macy's predicted they would be in 2021 before COVID hit, meaning a smaller presence than 2020. Maybe recovery for Macy's means staying in business, and not disappearing. Who knows. But I doubt recovery for Macy's means getting to a place that held more market share than they did in the end of 2019. But that's just my take.
« Last Edit: December 22, 2020, 08:42:29 AM by specialkayme »

specialkayme

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Re: Option prices are too high... time to sell options?
« Reply #15 on: December 22, 2020, 08:34:59 AM »
There's a Feb. 19 bear call spread at the 30 and 32.50 strikes that would yield $0.23 on $2.50 at risk per share, or 9.2% (55% annualized).
This being a thread about options, I'm curious about the "bear call spread" you mentioned, so I looked it up:
https://www.investopedia.com/terms/b/bearcallspread.asp

The "bear" part seems to mean the strategy profits off a falling share price.  I think that means you sell $30/sh calls and then buy $32.50/sh calls (for protection?).  Since CCL fell 2.5% today, those calls are getting cheaper:

CCL call $30 strike (2021 Feb 19) last sold for $0.60/sh
CCL call $32.50 strike (2021 Feb 19) last sold for $0.42/sh

An option of 100 shares means selling the lower strike for $60, and then buying the higher strike for $42, leaving you $18 to cover any losses.  In the worst case, CCL rises above the higher strike price, which costs $250 vs $18 invested.  Worst case loss of almost 1300%?  I might be reading all this wrong - feel free to correct me.

Best case, CCL closes below $30 (roughly). You gain $18. Worst case, CCL closes above $32.5 (roughly). You lose $232. Since CCL is currently at $20.48, you don't need prices to fall to gain. You just need it to not increase. Passage of time (theta) makes you money in this scenario, not falling prices. If you sold an ITM bear call spread, you'd need falling prices to make money.

If you're viewing $18 as the investment amount, than yes, it would be a loss of 1,288%. But most people view it based on the buying power reduction, or $232, for a 100% loss at full loss, or a 7.75% gain if fully profitable.

But keep in mind the market is estimating an 83% chance of full profit, and a roughly 12% chance of full loss (roughly).

I wouldn't chose that trade myself though.
« Last Edit: December 22, 2020, 08:50:05 AM by specialkayme »

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #16 on: December 22, 2020, 09:17:12 AM »
Right now I'm focused on Covid stocks, but selling ATM puts on index options is interesting.  Especially when combined with safety, like selling a put and buying a lower priced put (to avoid a wipeout in situations like March).

To flush this out a bit more, I might look at Macy's trading at $10.72.  I think a 20% drop is unlikely, so maybe PUT options with a $9 strike might be worth selling.

I think you're viewing this wrong. You're thinking in the form of dollars. You're viewing it as the stock is at $X, and a 20% drop is unlikely, so I'll look for a put at $Y. In the long run, you'll be taken to the cleaners thinking this way.

Instead, think in the form of probabilities in a standard deviation curve. That's the delta. Right now, a January 31 $9.5 M Put is selling for $0.59, with a -33 delta. That's one standard deviation move (roughly)
...
I agree viewing this as a math problem would be more accurate.  Where did you get "-33 delta" and conclude the one standard deviation?  I should probably be using the same website(s) ...

Are we talking about a standard deviation where 2/3rds of values are in the middle?  In that scenario, the 1/6th of values below the middle hurt me, while the top 1/6th are still profitable.  Wouldn't I lose 1/6th of the time?
(With two standard deviations, the 5% outside the range is also half favorable and half against me).

I'm also ignorant of how often PUT options are exercised.  I assume a PUT option that is barely in the money would rarely be exercised, except on it's expiration date.  But I don't know the relationship between a PUT option being in the money, and the percentage chance it gets exercised.

specialkayme

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Re: Option prices are too high... time to sell options?
« Reply #17 on: December 22, 2020, 10:04:43 AM »
I agree viewing this as a math problem would be more accurate.  Where did you get "-33 delta" and conclude the one standard deviation?  I should probably be using the same website(s) ...

From my broker. Look at any quote on an option, and pull up the greeks. I use TOS web portal. I have the "Bid", "Ask" and "Delta" columns open. You can also put the "Prob ITM" column up, which is a closer approximation to the odds it will be ITM than the delta, but for quick math sake the delta works good enough (now the delta opn the 9.5 put is -34, and probability is 42.83%). Technically a 1 std move would be the 9 put, -26 delta, 33.8% probability, for $0.41, but you get the idea.

Are we talking about a standard deviation where 2/3rds of values are in the middle?  In that scenario, the 1/6th of values below the middle hurt me, while the top 1/6th are still profitable.  Wouldn't I lose 1/6th of the time?
(With two standard deviations, the 5% outside the range is also half favorable and half against me).

If you sell a 1 std put, your looking at where the market indicates, based on it's implied volatility, the stock is likely to move within the time left of the option. In this instance, the market believes the IV is 76.83%, and there is a 68% chance the stock will move up or down $1.13 (roughly) in the next 38 days. There is a 32% chance that it will increase or decrease more than $1.13. A 16% chance (roughly) that it will decrease more than $1.13, thus putting your option in the money. But if you sell it for $0.40, you need it to move $1.53 to lose money. Which means it's less than 16% (I don't know the actual odds off the top of my head, but roughly 7% ish).

Now that's what the market believes could happen. Actual volatility is the unknown. Maybe the stock will be more volatile, and move up or down more than $1.13. Maybe less. That's where your speculation will come in.

To get in the weeds, that's not really accurate. A standard bell curve assumes equal distance on both tails, i.e. a stock has an equal probability of increasing as it does decreasing. In reality, the probability of option pricing standard deviations doesn't follow a standard bell curve. It suffers from kurtosis (there is a greater chance of 1 std moves), and skew. A 10 std move on a standard bell curve might put M at +/- $12, lets say. It can certainly go up $12, but it can't go negative, which means it can't move down $12. So the downside is capped, pushing the bell curve to the left, and increasing the right tail. But that's getting a little too specific for our discussion.

But that's really only viewing it in a fixed period of time. As in, if you sold the option today, closed your eyes, then opened them on January 29th, what are the odds today that on the last day something will happen. But the stock prices change, and the odds change with it. If the stock moves up $0.50 tomorrow, but the implied volatility stays the same, are you more or less likely that the stock will then drop $1.63 over the next 37 days? Probably less. If volatility drops, it's less likely to make a $1.13 move in 38 days, let alone in the time left in the option.

As a general rule of thumb, the option's delta is it's percentage chance it will expire in the money. So a 30 delta has a 30% chance of expiring in the money, and a 70% chance of expiring worthless. Double the delta, and you have the chance that the option will be within the money at some point during the option's life. So a 30 delta has a 60% chance that it will be in the money at some point in the next 38 days. Not accurate numbers, but good rough approximations.

Few people hold options to expiration though. As it isn't worth it. Most people will wait for an option they sold to decrease in value, then roll it out. If you sold the 38 day $0.40 option, and it dropped to $0.20 in a week, you just made 50% of your max profit in 7 days. Is it worth it to wait another 31 days for the other 50%? Probably not. Close it now, and sell another one further out. If the option goes in the money in 7 days, do you have a losing position? Not necessarily, as you knew there was a 60% chance it could do that, but you still have 31 days left. 

I'm also ignorant of how often PUT options are exercised.  I assume a PUT option that is barely in the money would rarely be exercised, except on it's expiration date.  But I don't know the relationship between a PUT option being in the money, and the percentage chance it gets exercised.

There are two types of options: European style, and American style. European options can only be exercised at the expiration, not early. American can be exercised at any time.

Generally, the further in the money an option is, and the closer it is to expiration, the more likely it will be exercised. Why? ITM and short term options have little extrinsic value. If you exercise an option, you lose the extrinsic value. But you could gain in something else, say a dividend.

Usually, the only reason an option will be exercised early, if american, is if there is a financial gain to do so. ~98% of the time, it's because of an upcoming dividend. An investor can exercise an option, hold the stock for the exdate, collect the dividend, then ditch the stock. Options get exercised around its exdate frequently, especially ITM options. Less likely for OTM (although not impossible).

Say the extrinsic value on the option is $0.50, but the projected dividend is $0.55. You can exercise the option (lose $0.50), hold it for a day (gain $0.55), then sell the stock ($0.05 gain). It becomes much more likely the closer to the exdate, and the closer to expiration, and the further ITM the option goes (as all have lower extrinsic value).

Some times they get exercised because someone exercised their option (usually because of an upcoming dividend). When you sell an option to someone, they likely had a spread themselves (meaning they sold an option to someone else, and bought an option from you). If the other party of their transaction exercises an option, they will exercise your option to transfer the stock. Of course, it doesn't really work this way, as option exercise is assigned randomly, not to the person you originally sold the option to, but you get the idea.

The remaining 1%? Someone makes a mistake, or just wants the stock (or get rid of the stock). Tax reasons, personal reasons, whatever. They just want to move the stock. It's rare though.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #18 on: December 22, 2020, 10:48:37 AM »
While most Covid-sensitive stocks have stopped paying dividends, I should double-check before selling American style options.  I found a decent explanation of the risks involved with options and dividends:
https://www.fidelity.com/learning-center/investment-products/options/dividends-options-assignment-risk

No wonder I haven't seen delta/assignment risk.  I've been using the online websites of Vanguard and Interactive Brokers, neither of which even list the option chain.  You have to select one expiration / strike at a time, and they just show level 1 pricing.

Looks like before I go further, I should learn "Trader Workstation" that IBKR provides.  I believe they have a module that displays options chains.  This image of their options chain display shows IV (implied volaility) and delta, which is a good sign.
https://www1.interactivebrokers.com/images/2015/webinarnotes/tws-optiontrader-01-optionstrader.png

So that's my homework - learn IBKR Trader Workstation, esp option chain display.

specialkayme

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Re: Option prices are too high... time to sell options?
« Reply #19 on: December 22, 2020, 10:55:38 AM »
So that's my homework - learn IBKR Trader Workstation, esp option chain display.

The IBKR mobile app has it as well, if you're so inclined.

I have an IBKR and a TD account (originally Scottrade back when that was a thing). IBKR's pricing structure is better, but it's a nightmare for me to manage options when I'm not in the Workstation (which I'm rarely at my home computer, so that's close to never). So I use TOS in my TD account to work through my trades, then place most of the orders through IBKR. Although I'm starting to shift more cash from IBKR to TD, as I'm too lazy to take the extra step.

There are a ton more communities using TOS than Workstation, so you can usually pick up other fun technical indicators that users share, if you use TOS. FYI

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #20 on: December 23, 2020, 09:27:42 AM »
Thanks for the advice - I have a TD Ameritrade account, so I could use ThinkOrSwim (TOS) for free.  It might be worth comparing it to IBKR's offering, keeping in mind there's more people to help with TOS if I get stuck or confused.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #21 on: December 24, 2020, 11:28:10 AM »
I notice in the John Hopkins Covid-19 data, infections look like they peaked and are heading downwards.  Although Thanksgiving was widely thought to make things worse, the growth rates continued smoothly right through Thanksgiving, without a spike in cases.  There were more cases - but at the same rate as before Thanksgiving.

I haven't learned TW or TOS (which display options chains), but I've sold more options anyways.  If those options detonate against me, losing -5x, I won't like it but my portfolio will be fine.

I resolved one problem: I had sold Macy's options that expired FEB 2021, which is too soon for vaccinations to lift Covid stocks.  So yesterday when Macy's stock rose +8%, I closed that position for 1/3rd of my cost.  I guess that's a +65% profit, but maybe that doesn't reflect the possible risk of loss, so maybe there's another way to describe it?

Covid-19 has an exponentially higher fatality rate for very old people.  After health care workers and long-term care residents, as of 4 days ago the CDC recommends people 75 and older get vaccinated.  According to statistica, there are 9.4M men and 13.2M women age 75 or older.  Assuming almost all 1.3M long-term care residents are in that age group, that means about 21.5M people should get vaccinated in the next phase.
https://www.cdc.gov/vaccines/acip/meetings/downloads/slides-2020-12/slides-12-20/02-COVID-Dooling.pdf
https://www.statista.com/statistics/241488/population-of-the-us-by-sex-and-age/

If there is "several weeks between waves" as one virologist said (on CNBC), that suggests a wave some time in February.  It seems like there's enough vaccine for people age 75 and older before February, which would be good news.  So I'm expecting the next wave will be blunted by vaccinations, and we might be near the low point now.

I bought some shorter-term Carnival call options, on the theory cruises will likely come back before other businesses.  People might not like old people getting vaccinated and going on a cruise, but I think it will happen.

Macy's stock dropped on Friday, Monday, Tuesday and today - only Wednesday had a big gain.  I found some deep in the money Macy's call options for 1 year ... costing 4.6% of time value.  Macy's went up +8% on Wednesday - it's definitely going up over 5% before 2021 ends.  That was a nice deal to spot.

I bought today because there's a chance this is the last wave without vaccinations, but if things get worse after this holiday weekend, we'll see it in early January.

specialkayme

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Re: Option prices are too high... time to sell options?
« Reply #22 on: December 24, 2020, 01:11:59 PM »
I'm not sure if you're referring to the Jan 21 $3 Call on M, currently trading at a mid price of $7.83 (with 1.1% intrinsic value), or the Jan 21 $5 Call on M, currently trading at a mid price of $6.23 (with 7.8% intrinsic value).

Either way, yes, it has small intrinsic value, and will suffer from little theta decay. But both have very high deltas ($3 Call is 98, $5 is 91), which means both will suffer from an extrinsic decline quickly if the underlying drops. Very close to the decline the underlying actually will have (98% for the $3 Call, and 91% for the $5 Call). So, your downside risk is fairly similar to holding shares of stock, and your upside is about the same as well. At that point, I'd rather hold the stock than the option. No decay at all in the stock, and the bid/ask spread is MUCH tighter exposing you to less slippage ($0.35 on the $3 option currently). But to each their own. That's the beauty of options. Unlimited ways to accomplish your goals.

Most people that target your strategy go for a 65-75 delta max. It's a good balance of risk/reward. The $8 Call has a 78 delta, and costs $4.27. The $10 Call has a 68 delta, and a cost of $3.35.

If leverage is your true play, I'm not sure you're getting what you want on those Calls. If the stock is at $10.74, and your direction is right, you're getting a 1.33X leveraged return on your $3 Call, or a 1.56X leveraged return on your $5 Call, but still exposing to some (small) theta decay, but large risk of declining in value from fall of extrinsic value. The $8 Call is closer to 1.96X, and the $10 Call is closer to 2.18X, larger return possibility, less loss if the underlying falls, but larger theta decay potential (although LEAPS don't really have much theta decay anyway).

But if you really think M will increase in the next year, but won't move much in the next 45 days, you could do a calendar spread. Buy the LEAP $8 Call (for $4.27) and sell the Feb $12 Call (for $0.71). If you're right, and M stays below $12 in the next 56 days, you just dropped the cost of your LEAP to $3.57. If you're wrong, and M goes above $12 in the next 56 days, you'll still make money. If you're really wrong, and M drops in price over the next 56 days, your Feb $12 Call will still expire worthless, reducing your risk. Then, in 56 days, you can re-evaluate (and sell another call, if you'd like). Just some thoughts.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #23 on: December 25, 2020, 08:38:37 AM »
Before revealing options or micro-cap holdings, I have to make sure there's a lot of liquidity - in this case, over 6,000 open interest on the Macy's call options I bought.
 I bought Macy's $5 strike 2022-Jan-21 call options for $6.26/share (including commission).

Macy's is $10.75/share, so a $5 strike is $5.75 of intrinsic value and $0.50 of time value.  A +5% gain would push the intrinsic value higher than my cost.  As an aside, this contracts implied volatility of 75% is the highest of any Jan 2022 strike price.

On news of a relief deal, Macy's gained +8%.  On Nov 9, the stock market opened with the news of a 95% effective vaccine, and Macy's gained +17% in one day (more than the vaccine maker!).  I believe Macy's could reach it's 5 year low ($14.75) or near it's pre-Covid level ($16/sh).  And there's pent up desire to go shopping normally again, which I think will temporarily boost sales.

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Re: Option prices are too high... time to sell options?
« Reply #24 on: December 29, 2020, 12:12:33 PM »
Today I looked at an Oil & Gas ETF I hold call options in (XOP), and noticed I could get 2 year options at 1.7x leverage ... for only 1.7% above the current stock price.  So where I started the thread saying options are too expensive ... could they now be too cheap?

At the time, I paid 57.6% of the stock price for my options.  56.3% of that was intrinsic value for deep in the money options.  The other 1.3% was time value, for options that have over 2 years remaining.

There's a leveraged ETF, GUSH (which I also own), that has 2x leverage but charges a 1.04% annual expense ratio.  Call that 2% for 2 years, getting 2.0x leverage.  For 2/3rds of that cost I get 2/3rds of the leverage, but without volatility drag (if XOP drops 20% and recovers, GUSH loses money).

yachi

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Re: Option prices are too high... time to sell options?
« Reply #25 on: December 29, 2020, 12:35:36 PM »
I have two stocks I own in a margin account.  I sold puts at prices I would be interested in buying at.  The puts are margin secured, so if they get exercised I would be carrying the stocks on margin.  It's a fun way to get a few extra percentage points, and it's awesome seeing the gains go from 0% to 88% and above.

ChpBstrd

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Re: Option prices are too high... time to sell options?
« Reply #26 on: December 29, 2020, 01:11:54 PM »
Today I looked at an Oil & Gas ETF I hold call options in (XOP), and noticed I could get 2 year options at 1.7x leverage ... for only 1.7% above the current stock price.  So where I started the thread saying options are too expensive ... could they now be too cheap?

At the time, I paid 57.6% of the stock price for my options.  56.3% of that was intrinsic value for deep in the money options.  The other 1.3% was time value, for options that have over 2 years remaining.

There's a leveraged ETF, GUSH (which I also own), that has 2x leverage but charges a 1.04% annual expense ratio.  Call that 2% for 2 years, getting 2.0x leverage.  For 2/3rds of that cost I get 2/3rds of the leverage, but without volatility drag (if XOP drops 20% and recovers, GUSH loses money).

For XLE ($37.50) the ~2-year 38 call (1.3% above current price) sells for about $6.88, which comes to ~9% of the collateral per year.
For XOP ($57.11) the ~2-year 58 call (1.6%...) sells for about $12.88, which comes to ~11% of the collateral per year.
For GUSH ($36.50) the ~2-year 37 call (1.4%...) sells for about $16.20, which comes to ~22% of the collateral per year, reflecting the fund's 2x leverage.

XLE and XOP have moved in lockstep this year, but XLE has outperformed XOP over a 5y period. XOP has a higher beta (2.68) than XLE (1.9), so that probably explains the slight difference in call prices.

OTOH, I can see the reason to take the opposite position and do a covered call. You'd lock in about a 10%/year return on XLE or XOP unless the funds were to drop even further, and PLUS you'd collect dividends along the way (about 5.5%/year in the case of XLE), and PLUS probably earn the 1.x% difference between the current price and the strike. 

ChpBstrd

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Re: Option prices are too high... time to sell options?
« Reply #27 on: December 29, 2020, 01:20:31 PM »
I have two stocks I own in a margin account.  I sold puts at prices I would be interested in buying at.  The puts are margin secured, so if they get exercised I would be carrying the stocks on margin.  It's a fun way to get a few extra percentage points, and it's awesome seeing the gains go from 0% to 88% and above.

At my brokerage one has to borrow the money in order to sell the puts, so interest expense is accrued while you wait for the put to expire worthless. Hopefully the put depreciates faster than the interest expenses.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #28 on: December 30, 2020, 08:25:54 AM »
Today I looked at an Oil & Gas ETF I hold call options in (XOP) ...

I paid 57.6% of the stock price for my options.  56.3% of that was intrinsic value for deep in the money options.  The other 1.3% was time value, for options that have over 2 years remaining.

For XLE ($37.50) the ~2-year 38 call (1.3% above current price) sells for about $6.88, which comes to ~9% of the collateral per year.
For XOP ($57.11) the ~2-year 58 call (1.6%...) sells for about $12.88, which comes to ~11% of the collateral per year.
For GUSH ($36.50) the ~2-year 37 call (1.4%...) sells for about $16.20, which comes to ~22% of the collateral per year, reflecting the fund's 2x leverage.

XLE and XOP have moved in lockstep this year, but XLE has outperformed XOP over a 5y period. XOP has a higher beta (2.68) than XLE (1.9), so that probably explains the slight difference in call prices.

OTOH, I can see the reason to take the opposite position and do a covered call. You'd lock in about a 10%/year return on XLE or XOP unless the funds were to drop even further, and PLUS you'd collect dividends along the way (about 5.5%/year in the case of XLE), and PLUS probably earn the 1.x% difference between the current price and the strike.
Portfolio Visualizer says XLE and XOP are 0.90 correlated since Jan 1, 2020.  I used the "20 days" of "daily returns" options on their asset correlation calculator.
https://www.portfoliovisualizer.com/asset-correlations

XOP has gained +2.5% today, so the call options I bought already broke even.  I'm investing in Covid sensitive stocks until recovery.  I have plenty of evidence this works extremely well, so maybe that will help explain my views:

XOP was $30/sh on Mar 23, and is now $58.74/sh, for a +96% gain.
Including the November vaccine news, XOP is up +38% in 3 months.
And yet despite those gains, XOP is down 39% YTD

What I see is an ETF that makes big gains on Covid recovery news.  Figuring that 0.61 x 1.64 = 1.00, there's room for a 64% gain if XOP recovers.  And buying call options with 1.7 leverage turns 64% into 109% gain.  So I'm not interested in selling covered calls on Covid sensitive stocks, because I expect the gains from buying calls to be much greater.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #29 on: December 30, 2020, 11:21:20 AM »
I've mentioned a lot of risky call options, so here's one that's not so risky:
Vanguard Total Stock Market (VTI), which is trading at $194/share.

Call options expiring 2023-Jan-20 with a $100/sh strike cost $97/sh.
$100 + $94 = $194, so $94/sh is intrinsic value - what it's worth if sold now.
The other $3/sh buys double leverage against the total stock market for 2 years.  It breaks even after a 1.5% rise in the stock price in 2 years.

A more popular pick is SPDR S&P 500 ("SPY"), trading at $372.50/sh.
Call options expiring 2023-Jan-20 with a $200/sh strike cost $176/sh.
$200 + $172.50 = $372.50, with the other $3.50/sh being time value.
It breaks even after a gain of (3.50 / 372.50 =) 0.9% in two years.

ProShares Ultra charges 0.9% per year for 2x leverage.  Seems like deep in the money S&P 500 call options are a better deal, and without volatility drag.

ChpBstrd

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Re: Option prices are too high... time to sell options?
« Reply #30 on: December 30, 2020, 01:07:55 PM »
Today I looked at an Oil & Gas ETF I hold call options in (XOP) ...

I paid 57.6% of the stock price for my options.  56.3% of that was intrinsic value for deep in the money options.  The other 1.3% was time value, for options that have over 2 years remaining.

For XLE ($37.50) the ~2-year 38 call (1.3% above current price) sells for about $6.88, which comes to ~9% of the collateral per year.
For XOP ($57.11) the ~2-year 58 call (1.6%...) sells for about $12.88, which comes to ~11% of the collateral per year.
For GUSH ($36.50) the ~2-year 37 call (1.4%...) sells for about $16.20, which comes to ~22% of the collateral per year, reflecting the fund's 2x leverage.

XLE and XOP have moved in lockstep this year, but XLE has outperformed XOP over a 5y period. XOP has a higher beta (2.68) than XLE (1.9), so that probably explains the slight difference in call prices.

OTOH, I can see the reason to take the opposite position and do a covered call. You'd lock in about a 10%/year return on XLE or XOP unless the funds were to drop even further, and PLUS you'd collect dividends along the way (about 5.5%/year in the case of XLE), and PLUS probably earn the 1.x% difference between the current price and the strike.
Portfolio Visualizer says XLE and XOP are 0.90 correlated since Jan 1, 2020.  I used the "20 days" of "daily returns" options on their asset correlation calculator.
https://www.portfoliovisualizer.com/asset-correlations

XOP has gained +2.5% today, so the call options I bought already broke even.  I'm investing in Covid sensitive stocks until recovery.  I have plenty of evidence this works extremely well, so maybe that will help explain my views:

XOP was $30/sh on Mar 23, and is now $58.74/sh, for a +96% gain.
Including the November vaccine news, XOP is up +38% in 3 months.
And yet despite those gains, XOP is down 39% YTD

What I see is an ETF that makes big gains on Covid recovery news.  Figuring that 0.61 x 1.64 = 1.00, there's room for a 64% gain if XOP recovers.  And buying call options with 1.7 leverage turns 64% into 109% gain.  So I'm not interested in selling covered calls on Covid sensitive stocks, because I expect the gains from buying calls to be much greater.

The long call vs. covered call choices have very different risk profiles. Both could make good money at the same time if the oil stocks go up dramatically. However, the covered call makes money even if the underlying stock falls by <9% or <11%. Meanwhile, if the underlying stock fails to go up beyond 9% or 11%, the long call will be a complete loss. Yet, the covered call also limits potential gains, while the long call could go to the moon and deliver 100%+ returns as noted.

Long call: starts to profit at 9% or 11% above current price. 100% loss otherwise.
Covered call: starts to profit at 9% or 11% below current price. Still lots of loss potential, but max annual gains are around 15% with dividends and all included.

Those deep ITM calls on VTI and SPY are an intriguing way to cheaply double-leverage one's portfolio and exploit an expected Covid resolution. The downside would be if 2021 is more like 2000 than 2009. We're all expecting resolution of the pandemic in 2021, but there are also all the ingredients present for a 2-3 year valuations landslide like we saw in 2000. A blip of inflation could set it off just like back then, and you'd be double levered.

I'm most tempted to gain more than 100% exposure by doing something like the following AA:
     80% long stock
     10% OTM by about 10% long puts for protection
     10% ATM long calls for leverage

For SPY, such a portfolio would be limited to a maximum loss of about 18% for the next 2 years (total loss on 10% allocated to calls plus the ~10% gap down to put strike on 80% of the portfolio), incurred if the market dropped by about 10%. Meanwhile, it would have upside exposure of the 80% long stock allocation plus roughly another 90% for the long calls* equals 170% total upside exposure. I like those odds, and I also like the idea of selling the highly appreciated put next time the market is 20% down and going unhedged and levered for the recovery.

Also, the SPY December 2023 LEAPS just went on the market Their ATM ($370 strike) cost of put protection is about 5.1% per year right now. ATM calls are even cheaper at 4.4% per year. Both are cheaper on an annual basis than the January 2023's.

*must subtract the 10% price of the calls from the 100% exposure, because the price is mostly time value - all lost by expiration.

specialkayme

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Re: Option prices are too high... time to sell options?
« Reply #31 on: December 30, 2020, 03:24:57 PM »
Vanguard Total Stock Market (VTI), which is trading at $194/share.

Call options expiring 2023-Jan-20 with a $100/sh strike cost $97/sh.
$100 + $94 = $194, so $94/sh is intrinsic value - what it's worth if sold now.
The other $3/sh buys double leverage against the total stock market for 2 years.  It breaks even after a 1.5% rise in the stock price in 2 years.

There is a reason the market is putting such little intrinsic value on those options. You lose out on dividends over 2 years, and it moves at 0.89 delta. You expose yourself to a number of other risk factors, including changes in volatility and interest rates, that the underlying doesn't have. Few would chose this option over holding the underlying. Hence the fairly large spread, and exceptionally low open interest.

ATM options typically move much more favorably. Better risk/reward, better leverage, better optimization of the greeks. In particular, volatility smile.

But to each their own. This is a trade I would definitely pass on though. There are a ton of better trades to capture what you want to accomplish.

ProShares Ultra charges 0.9% per year for 2x leverage.  Seems like deep in the money S&P 500 call options are a better deal, and without volatility drag.

Proshares Ultra doesn't suffer from volatility drag. That's a common misconception. VXX suffers from volatility drag (where it has to buy a more expensive product and sell a cheaper product, constantly losing value over time). Leveraged ETFs, by nature, don't necessarily. The leveraged nature of the fund just means that over the long run, the leveraged ETF will drift away from a pure leveraged return of it's benchmark, as the leveraged ETF is only seeking a daily leveraged return. I.E., UPRO seeks to return 3x the daily return of SP500, but not necessarily the monthly or yearly. Compound returns could mean more, or less returns, depending on the sequential nature of the returns.

By way of example, SPY from 2006-2020 went from 125.19 to 371.95, or a 197% gain.
A 3x gain should return a 591% return during that time period. If a leveraged fund suffered from "volatility drag" it would return something less than a 591% return.
Meanwhile, UPRO (3x SP500 return) from 2006-2020 went from 2.2525 (split adjusted) to 75.68, or a 3,259% gain.
It didn't suffer from volatility drag. If it did, it would have returned less than 3x the undelrying. Just compound drift.

From 2006-2020, the drift would have worked in your favor. It could have cut the other way though.

TQQQ did the same thing. But it all depends. TMF returned 1.87x the return of TLT over the past 15 years, shy of it's 3x compound rate. But not due to volatility drag. Just compound drift.

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Re: Option prices are too high... time to sell options?
« Reply #32 on: December 31, 2020, 02:26:21 AM »
I think all daily leveraged ETFs suffer from volatility drag, but I think we disagree, so let me put forth how I view it.

"This leveraged ProShares ETF seeks a return that is 2x the return of its underlying benchmark (target) for a single day,"
https://www.proshares.com/funds/sso.html

Volatility drag mostly matters for big moves, so let's take a 20% drop and recovery.  The ETF falls from $100 to $80 (20% drop).  And the next day, goes from $80 to $100 (a 25% gain: 0.80 x 1.25 = 1.00).

A leveraged ETF just follows the 2x path of the above.  On the first day, it drops 20% x 2 or 40%, going from $100 to $60.  Now it gets double the move of the underlying ETF, so 25% x 2 = 50%.  Once the leveraged ETF takes a hit, it can't recover - it just has to follow 2x the path of the underlying security.

Now from theory to actual performance: YTD, SPY is +18% and SSO is +20%.  That's volatility drag impacting SSO's returns, causing it to be 1.1x of SPY.
https://etfdb.com/etf/SPY/#performance
https://etfdb.com/etf/SSO/#performance

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #33 on: December 31, 2020, 02:43:44 AM »
Vanguard Total Stock Market (VTI), which is trading at $194/share.

Call options expiring 2023-Jan-20 with a $100/sh strike cost $97/sh.
$100 + $94 = $194, so $94/sh is intrinsic value - what it's worth if sold now.
The other $3/sh buys double leverage against the total stock market for 2 years.  It breaks even after a 1.5% rise in the stock price in 2 years.

There is a reason the market is putting such little intrinsic value on those options. You lose out on dividends over 2 years, and it moves at 0.89 delta. You expose yourself to a number of other risk factors, including changes in volatility and interest rates, that the underlying doesn't have. Few would chose this option over holding the underlying. Hence the fairly large spread, and exceptionally low open interest.

ATM options typically move much more favorably. Better risk/reward, better leverage, better optimization of the greeks. In particular, volatility smile.

But to each their own. This is a trade I would definitely pass on though. There are a ton of better trades to capture what you want to accomplish.
Good point about dividends, with VTI offering 1.44% dividends per year right now.  The 2 year option sacrifices 2.88% in dividends that a stock holder would receive (and reinforces your point that option holders may exercise their options to grab a dividend).

As I understand it, the right way to view VTI options is with leverage versus time decay.  If nothing happens, the option loses value to time decay.  But if the stock goes up, the call option follows, and can immediately be sold at a profit.

The way I view it (the wrong way!), I look at option value at expiration.  Paying $20.80 for an at the money (ATM) option is all time value.  If the stock goes up $19.30, or 10%, that option expires worthless.  In viewing options at their expiration value (intrinsic value only), I arrive at using deep in the money options.

specialkayme

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Re: Option prices are too high... time to sell options?
« Reply #34 on: December 31, 2020, 05:37:24 AM »
I think all daily leveraged ETFs suffer from volatility drag, but I think we disagree, so let me put forth how I view it.

. . .

Now from theory to actual performance: YTD, SPY is +18% and SSO is +20%.  That's volatility drag impacting SSO's returns, causing it to be 1.1x of SPY.
https://etfdb.com/etf/SPY/#performance
https://etfdb.com/etf/SSO/#performance

What you're explaining isn't volatility drag.

"Volatility drag refers to the difference between arithmetic and compound investment returns.  Compound mean returns are always less than or equal to arithmetic mean returns." [Emphasis mine].
http://www.annuitydigest.com/volatility-drag/definition#:~:text=Volatility%20drag%20refers%20to%20the,on%20compound%20versus%20arithmetic%20returns).

In order for it to be volatility drag, the actual returns must be less than the leveraged multiple of the underlying. Except with leveraged ETFs, it isn't always less. Sometimes it's less, sometimes it's more.

Compare SPY's and SSO's gain in various time periods over the past 15 years again.
1 Year Gain - SPY 16.12%; SSO 19.62%; 1.21x Return of SSO over SPY
3 Year - SPY 19.54%; SSO 64.34%; 3.29x Return of SSO over SPY
5 Year - SPY 90.85%; SSO 154.19%; 1.69x Return of SSO over SPY
15 Year - SPY 197.29%; SSO 410.83%; 2.08x Return of SSO over SPY

In some time periods, and in some years, SSO returns less than 2x the return of SPY. But in other time periods, and in other years, it returns more than 2x the return of SPY. The results are compounded for 3x leveraged ETFs. In order for it to be volatility drag, every SSO number MUST be less than it's SPY equivalent. But it isn't. So it isn't volatility drag. It would be better described as "volatility drift" or "compound drift."

There is actually a very lengthly and indepth discussion on the topic in another forum. Search for HEDGEFUNDIE's Excellent Adventure (and get ready to lose a few days, if not a few weeks of your life reading). He created a portfolio consisting of UPRO and TLT and did a number of backtests showing its historical performance is solid. The largest criticism of the portfolio is that UPRO and TLT suffer from "volatility drag." But again, they don't. Their returns just drift away from the underlying. It's explained better there than I'm doing.

The reason why so many people think all leveraged ETFs suffer from volatility drag is as a result of VXX. In order to get a consistent return, it must sell a 3 month contract (a cheaper one) and it must buy a 6 month contract (a more expensive one). Assuming volatility increases or stays the same over time (which, over the long term volatility can't continue to increase perpetually), the fund must decrease in value. It then encounters reverse splits to stop itself from disappearing. But not all leveraged ETFs operate that way. In order to return 2x the returns of SPY, SSO will "borrow" money or "pay back" previous loans from its holding entity in order to account for any variation beyond what buying and selling their contracts had. So if SSO had to sell a 3 month contract (a cheaper one) and buy a 6 month contract (a more expensive one) in a given day, and if that transaction would have put it at 1.8x SPY for the day, it will take a loan for the 0.2x to get it back to 2x.

Of course, it isn't a long term sustainable model, but it was never intended to be. UGAZ was delisted for that reason, the owner wasn't willing to fund it anymore. But UPRO and TQQQ are significantly more popular. So who knows.

But the point is you shouldn't think down on leveraged ETFs because they "drag". They don't. They just drift. For better (in some years) or for worse (in some years).
« Last Edit: December 31, 2020, 06:08:11 AM by specialkayme »

specialkayme

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Re: Option prices are too high... time to sell options?
« Reply #35 on: December 31, 2020, 06:05:52 AM »

As I understand it, the right way to view VTI options is with leverage versus time decay.  If nothing happens, the option loses value to time decay.  But if the stock goes up, the call option follows, and can immediately be sold at a profit.

The way I view it (the wrong way!), I look at option value at expiration.  Paying $20.80 for an at the money (ATM) option is all time value.  If the stock goes up $19.30, or 10%, that option expires worthless.  In viewing options at their expiration value (intrinsic value only), I arrive at using deep in the money options.

Well, I'm not sure there is a right and a wrong way to view options. It depends on what you're trying to get out of it.

Someone who is hedging a position will often look at an option's value at expiration. They'll buy an OTM put not because they think the stock will go down, but because of protection. They're expecting (or at least hoping) the value of the option will decrease/disappear by expiration, and so they're willing to hold it to expiration. If they're hedging against a loss on a certain date, they'll look to the projected value as of that certain date.

For example, if I sign a EURO 1M purchase contract, payable 1 year from now, and I live in the US, I'm running a risk the dollar will fall in value over the next year. So I might look to hedge that risk by buying a EUR/USD option, targeted for around the time when I have to pay the contract, or 1 year from now. Maybe the dollar falls, and I cash in on my hedge and pay the same amount in dollars I was budgeting for. Maybe the dollar doesn't fall, and my option expires worthless. But I'm ok with that, because I only cared about its value as of the expiration date.

But we aren't hedging risks here. We're investing.

You're thinking about options as a traditional buy and hold investor would. What is the value today, what is the value at expiration. But options don't really work like that. At least, not to the vast majority that trade options. Options are RARELY held to expiration by traders/investors. They're almost always rolled or sold, because they decay in nature. How quickly depends on the option.

So looking at your LEAP VTI option, lets say you want to repeat this strategy over the next 20 years. One option would be to hold that LEAP option to expiration, in Jan 2023, take assignment or sell for profit, then buy another 2 year leap at that time. As the option gets closer to expiration, the greeks start changing faster. Delta won't continue to increase as it gets further in the money, theta will increase, you'll be exposed to more risk the closer to expiration you get. So, why not sell it early, and roll it to another expiration that's longer out, and avoid the risk? In Jan 2022 you could sell the 2023 option and buy a 2024 option. You decrease the risk that weird things happen at the end. In theory, you could do that every six months instead of every year.

But then, if you're going to sell in a year, why do you need to go so far ITM? You aren't expecting the option to be in the money within a year. You're just expecting VTI will be moving in your direction over the next year, meaning you're going further in the money. So if you are only expecting the underlying to move in your direction, getting you further in the money, it doesn't matter if you buy a $100 strike or a $120 strike. But the $120 is cheaper, gets you better returns, and utilizes the greeks better. You can go closer to ATM and get better leverage. You'll also get better movement from the greeks over the next year with an ATM as opposed to a deep ITM option. Theta won't hurt you much with 2 years left on an option. It's decay doesn't really start hitting you until the last 45 days (relatively speaking). So you're better off rolling it anyway before then.

By thinking it this way, the question isn't what will the value of VTI be 2 years from now. Instead, it's how much more will VTI move compared to a decay of the option. And that equation typically shows you get the best odds the closest you get to ATM. Of course, it comes with more risk too. Which is why most don't buy/sell exactly at the money. Maybe target a 60-70 delta call.

But hey, whatever works for you. If you think its the right investment for you, go for it. I once thought that way too, before I really started trading and understanding options (at least, more than I did then :) ).
« Last Edit: December 31, 2020, 06:15:14 AM by specialkayme »

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #36 on: December 31, 2020, 06:46:51 AM »
(I'm replying to your earlier post, on volatility drag)

I don't see where I'm using an average of returns?  You're calling that arithmetic returns, but my example uses returns multiplied together.

But I can't explain UPRO's 3 year performance, so let's focus on that.  As you point out, volatility drag should always pull UPRO's performance below 3x, so above 3x can't be explained by volatility drag.  I'm wrong about UPRO ... do you think that's true of every ETF?

You mentioned that leveraged ETFs borrow to make up for reduced exposure.  Is there a way I could see this for myself?  Or see which leveraged ETFs use this more effectively?

An example would help me - let's look at Vanguard REIT (VNQ) and two leveraged ETFs:  ProShares Ultra Real Estate (URE) and Direxion 3x Real Estate (DRN).  Every single year, URE and DRN drag below their leverage multiples (of 2x and 3x).
https://finance.yahoo.com/quote/VNQ/performance?p=VNQ
https://finance.yahoo.com/quote/URE/performance?p=URE
https://finance.yahoo.com/quote/DRN/performance?p=DRN

(Maybe it's REIT income, which is currently at 4% for Vanguard's VNQ)
https://www.nasdaq.com/market-activity/funds-and-etfs/vnq/dividend-history

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Re: Option prices are too high... time to sell options?
« Reply #37 on: December 31, 2020, 07:13:15 AM »
...
     80% long stock
     10% OTM by about 10% long puts for protection
     10% ATM long calls for leverage

For SPY, such a portfolio would be limited to a maximum loss of about 18% for the next 2 years (total loss on 10% allocated to calls plus the ~10% gap down to put strike on 80% of the portfolio), incurred if the market dropped by about 10%. Meanwhile, it would have upside exposure of the 80% long stock allocation plus roughly another 90% for the long calls* equals 170% total upside exposure. I like those odds, and I also like the idea of selling the highly appreciated put next time the market is 20% down and going unhedged and levered for the recovery.

Also, the SPY December 2023 LEAPS just went on the market Their ATM ($370 strike) cost of put protection is about 5.1% per year right now. ATM calls are even cheaper at 4.4% per year. Both are cheaper on an annual basis than the January 2023's.

*must subtract the 10% price of the calls from the 100% exposure, because the price is mostly time value - all lost by expiration.
I divide my investments into "index funds and index tilts" which have broad market exposure.  Then I have my market timing section, with things like GUSH (2x XOP) or DRN (3x VNQ ).  And finally I have very high risk call options and some beaten up stocks.

Earlier this year, I bought out of the money call options, and the returns on those were insane.  Now stock prices are higher, and much closer to their possible recovery point.  And I haven't switched to viewing it as a contest between an option's gains vs it's time decay.

Back to your example, 2023-Dec ATM calls on SPY (now $372/sh) versus puts for protection.
The call options at $370 last sold for $21.52, which is $2 intrinsic value and 5.2% time value.  After it goes up 5.2%, it takes off with 17x leverage.  I agree, that's pretty amazing.

So you view the 80% stocks and 10% protective puts together?  Protective puts at $335 strike cost $11.46/sh, which is 32.5x cheaper than the stock.  So if you invested 80% in S&P 500, I think you could spend 2.5% on protective puts.  Or even have 87% long stock and 3% protective puts.

ChpBstrd

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Re: Option prices are too high... time to sell options?
« Reply #38 on: December 31, 2020, 08:11:40 AM »

Back to your example, 2023-Dec ATM calls on SPY (now $372/sh) versus puts for protection.
The call options at $370 last sold for $21.52, which is $2 intrinsic value and 5.2% time value.  After it goes up 5.2%, it takes off with 17x leverage.  I agree, that's pretty amazing.

So you view the 80% stocks and 10% protective puts together?  Protective puts at $335 strike cost $11.46/sh, which is 32.5x cheaper than the stock.  So if you invested 80% in S&P 500, I think you could spend 2.5% on protective puts.  Or even have 87% long stock and 3% protective puts.

Yahoo shows $49.26 as the last price for December 2023 calls at the 370 strike. That's $47.76 in time value, or about a +12.9% move required to break even at expiration ~3 years from now. December 2023 puts at 335 last sold for $43.48. Maybe check your expiration date selection?

But yes, in general this idea is a protective put plus a long call, although long stock plus long strangle is also accurate. Compared to an all-stock B&H strategy, it would underperform if SPY ends up relatively flat (due to time decay of both long options, could have 20% loss if SPY is flat vs. 0% return for B&H), and would outperform if SPY either plummets or rockets (due to limited losses and levered upside).

There is a reason the market is putting such little intrinsic value on those options.

Pretty sure you meant time value in this context.

The biggest risk of deep-ITM options is the loss of intrinsic value. E.g. If the stock drops 10%, a particular ITM option might lose 50% of its intrinsic value, and that is only partially offset by an increase in time value due to volatility and being closer to the money. I simply phrased this as leverage earlier, but this is the more technical explanation of the risk. At least with ATM options, if our thesis all goes to shite we lose less money than we would have with ITM. So my point is, we should not look at intrinsic value as "safe money we will get back at expiration" because it is at risk in an unpredictable way. At least with time value we can plan for the decay with fair accuracy.

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Re: Option prices are too high... time to sell options?
« Reply #39 on: December 31, 2020, 11:29:34 AM »
... Protective puts at $335 strike cost $11.46/sh, which is 32.5x cheaper than the stock.
... December 2023 puts at 335 last sold for $43.48. Maybe check your expiration date selection?
Oops, agreed.

But yes, in general this idea is a protective put plus a long call, although long stock plus long strangle is also accurate. Compared to an all-stock B&H strategy, it would underperform if SPY ends up relatively flat (due to time decay of both long options, could have 20% loss if SPY is flat vs. 0% return for B&H), and would outperform if SPY either plummets or rockets (due to limited losses and levered upside).
With ATM options, if the S&P 500 is down 2% for 3 years, 100% of the investment is lost.  Right now $365 strike calls for 2023-Dec cost 14% of the stock price.  Oddly enough, I can't find any bad examples in Yahoo's 2000-2020 data.

2000-2003 the call expires worthless ... while other people lose 37% instead of 14%.
2001-2004 the volatile markets do better, but it's -12% vs -14%.  Not a big deal.
2007-2009, with the 2008 crisis in the middle, is a -16% loss for others.

Although I'm using a small data set, it makes sense that 3 year options have more time to recover than 1-year or 2-year options.  Certainly for 2000-2020, you're right that ATM options are better than deep in the money options.

specialkayme

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Re: Option prices are too high... time to sell options?
« Reply #40 on: December 31, 2020, 12:27:45 PM »
But I can't explain UPRO's 3 year performance, so let's focus on that.  As you point out, volatility drag should always pull UPRO's performance below 3x, so above 3x can't be explained by volatility drag.  I'm wrong about UPRO ... do you think that's true of every ETF?

If you're asking if every leveraged ETF has the potential to act that way, then almost yes. Depending on how the leveraged ETF achieves it's leveraged nature.

You mentioned that leveraged ETFs borrow to make up for reduced exposure.  Is there a way I could see this for myself?

A member on the bogleheads forums showed me a year or so back when one was borrowing cash left and right. He thought it was spelling the end of the fund (it wasn't) as the owner would pull the plug eventually (they didn't), but I don't remember where it is.

Or see which leveraged ETFs use this more effectively?

I'm not really sure what you're asking here. Providing they are using the funds to achieve the intended results, they are all equally effective.

Most try not to constantly borrow funds. They switch funds from more leveraged assets to less leveraged assets. But eventually if they go more leveraged, they need more funds.

An example would help me - let's look at Vanguard REIT (VNQ) and two leveraged ETFs:  ProShares Ultra Real Estate (URE) and Direxion 3x Real Estate (DRN).  Every single year, URE and DRN drag below their leverage multiples (of 2x and 3x).
https://finance.yahoo.com/quote/VNQ/performance?p=VNQ
https://finance.yahoo.com/quote/URE/performance?p=URE
https://finance.yahoo.com/quote/DRN/performance?p=DRN

(Maybe it's REIT income, which is currently at 4% for Vanguard's VNQ)
https://www.nasdaq.com/market-activity/funds-and-etfs/vnq/dividend-history

VNQ moved flat over the past 15 years. So, obviously any leveraged multiple will underperform. It's the way the math works. But it isn't "volatility drag."

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Re: Option prices are too high... time to sell options?
« Reply #41 on: January 02, 2021, 07:48:13 AM »
An example would help me - let's look at Vanguard REIT (VNQ) and two leveraged ETFs:  ProShares Ultra Real Estate (URE) and Direxion 3x Real Estate (DRN).  Every single year, URE and DRN drag below their leverage multiples (of 2x and 3x).
https://finance.yahoo.com/quote/VNQ/performance?p=VNQ
https://finance.yahoo.com/quote/URE/performance?p=URE
https://finance.yahoo.com/quote/DRN/performance?p=DRN

(Maybe it's REIT income, which is currently at 4% for Vanguard's VNQ)
https://www.nasdaq.com/market-activity/funds-and-etfs/vnq/dividend-history
VNQ moved flat over the past 15 years. So, obviously any leveraged multiple will underperform. It's the way the math works. But it isn't "volatility drag."
URE and DRN didn't exist 15 years ago.  Plus, that includes the worst hit to real estate in memory, when VNQ lost 71% between it's Feb 2007 peak and it's low point in Feb 2008.  Meanwhile VNQ has positive returns for 5 and 10 years.

I think it's more interesting to look at more recent performance, like 2016-2019:
VNQ's performance was +8.53% .. +4.95% .. -5.95% .. +28.91%
URE (2x) performance : +10.38% .. +16.57% .. -13.53% .. +57.39%
DRN (3x) performance : +13.32% .. +7.72% .. -25.02% .. +81.97%

I suspect URE pushed some of it's 2016 performance into 2017.  For that time frame, VNQ's performance was +14% and URE's was +28%.  Which doesn't explain DRN gaining +22% ... which is why I wonder if some ETFs are managed better than others.

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Re: Option prices are too high... time to sell options?
« Reply #42 on: January 02, 2021, 07:59:10 AM »
@ChpBstrd - I thought about your allocation some more, and I see protective puts as weaker than they seem.  There's a problem of market timing, and the path the market takes after you buy the puts.

If your puts are in the money, do you exercise them?  After a -20% drop or a -40% drop?  If you use them at -20%, the -40% drop inflicts extra damage.  If you wait for -40%, the market might not drop that far.  Market timing of a put option could be tricky.

If you buy a 3 year put, the market can go up one year and drop back to flat the next year.  The market is still above the level of the PUT, so it doesn't provide protection - it's out of the money.  I imagine solving that problem requires higher spending on PUT protection.

Last month I sold PUTs on certain companies that I expect to recover.  Since I'd lose a lot if the companies went bankrupt, I bought PUTs at much lower prices to mitigate some of that risk of loss.  That's for single-company risk, which is not true for the S&P 500.  (The S&P 500 cannot go to $0, because I'll buy the 500 biggest companies in the U.S. for $5000 ... and I'm sure others would pay much more).

ChpBstrd

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Re: Option prices are too high... time to sell options?
« Reply #43 on: January 02, 2021, 08:05:16 PM »
@ChpBstrd - I thought about your allocation some more, and I see protective puts as weaker than they seem.  There's a problem of market timing, and the path the market takes after you buy the puts.

If your puts are in the money, do you exercise them?  After a -20% drop or a -40% drop?  If you use them at -20%, the -40% drop inflicts extra damage.  If you wait for -40%, the market might not drop that far.  Market timing of a put option could be tricky.

If you buy a 3 year put, the market can go up one year and drop back to flat the next year.  The market is still above the level of the PUT, so it doesn't provide protection - it's out of the money.  I imagine solving that problem requires higher spending on PUT protection.

Last month I sold PUTs on certain companies that I expect to recover.  Since I'd lose a lot if the companies went bankrupt, I bought PUTs at much lower prices to mitigate some of that risk of loss.  That's for single-company risk, which is not true for the S&P 500.  (The S&P 500 cannot go to $0, because I'll buy the 500 biggest companies in the U.S. for $5000 ... and I'm sure others would pay much more).

I've thought about this too. Puts are an expensive way to reduce portfolio volatility if that's all you use them for. At some point, in the middle of a scary correction, you have to get rid of the put in order to profit from it. If we're not willing to sell the put during a correction, what use is it really?

I settled on 20% down from a recent peak as my criteria for exiting a hedge. 20% corrections happen frequently enough (about every 7 years historically, but I think we're in an era with more volatility than historically) that a long-duration put has at least some likelihood of profitability. 10% is too low to offer enough protection to worry about, and 30% drops are too rare. December 2018 was an example of where this strategy worked perfectly for me. But of course it's a cost/risk tradeoff just like your auto insurance deductible.

The biggest gains have come from having the confidence to be aggressively allocated to stocks, instead of say, a 60/40 or 70/30 portfolio containing deadweight bonds. In a sense, I'm using puts instead of bonds, and using hedges instead of rebalancing.

The main 2 reasons for buying as much duration as you can are: 1) lower decay rate per year if held a long time, and 2) you don't want to be in the middle of a financial crisis, with high volatility and options prices, when it's time to roll your puts.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #44 on: January 03, 2021, 06:56:06 AM »
With 3 year PUT options at a strike -10% from the current price:
1999-2001: +21% .. -9% .. -12%  (last 2 yrs -20% drop, PUT isn't in the money)
2006-2008: +16% .. +5% .. -37% (last 2 yrs -34% drop, PUT captures 13%)

But that neglects your other point, that higher leverage tends to be more profitable.  Visiting Yahoo Finance's options prices again, I looked at Dec 2023 call options with various amounts of leverage (2x 4x 8x 16x 22x 53x).  From 1972-2020 the annualized return of the S&P 500 has been 10.55%, or 35% over 3 years.  So how does each level of leverage do in that +35% scenario?
2x: (35 -  1)   x2 = 68%   ($200 strike cost $177)
4x: (35 -  6)   x4 = 116%  ($310 strike cost $87)
8x: (35 - 13) x 8 = 176%  (ATM $375 strike cost $47)
16x: (35 - 20) x 16 = 240% (OTM $425 strike cost $23)
22x: (35 - 25) x 22 = 220% ($450 strike cost $17)
53x: (35 - 36) x 53 = -53% ($500 strike cost $7)

S&P 500 long-dated call options (LEAPs) seem like a good approach if it can be kept going in bad years.  Not only will that part of the portfolio expire worthless, but the rest of the portfolio has taken a loss .. and needs to fund a new call option.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #45 on: January 13, 2021, 08:25:54 AM »
Another example of options costing too much... Callon Petroleom (CPE) options.  You could buy CPE stock at $15.44/sh, or you could buy very deep call options with a $1 strike price, expiring 2023.  The stock is a better deal in every respect.

The $1 strike options cost $17/sh.  When CPE reaches $18/sh, you break even ... but then the stock grows with 1.0x leverage, and the call options have 0.9x leverage.  The options can never catch up to the stock.  Even better, in a bankruptcy, you lose 110% of the stock's drop in value.

ChpBstrd

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Re: Option prices are too high... time to sell options?
« Reply #46 on: January 13, 2021, 12:33:55 PM »
Another example of options costing too much... Callon Petroleom (CPE) options.  You could buy CPE stock at $15.44/sh, or you could buy very deep call options with a $1 strike price, expiring 2023.  The stock is a better deal in every respect.

The $1 strike options cost $17/sh.  When CPE reaches $18/sh, you break even ... but then the stock grows with 1.0x leverage, and the call options have 0.9x leverage.  The options can never catch up to the stock.  Even better, in a bankruptcy, you lose 110% of the stock's drop in value.

I would expect to get a price somewhere between the current bid price of $12 and ask price of $17, but never lower than the current price - $1 + at least some TV. The last price was 15.38 (breakeven 16.38), and no contracts exchanged hands today. If CPE falls back below $5, the $1 strike options will be worth a decent amount more than $4.

MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #47 on: January 14, 2021, 08:49:59 AM »
Another example of options costing too much... Callon Petroleom (CPE) options.  You could buy CPE stock at $15.44/sh, or you could buy very deep call options with a $1 strike price, expiring 2023.  The stock is a better deal in every respect.

The $1 strike options cost $17/sh.  When CPE reaches $18/sh, you break even ... but then the stock grows with 1.0x leverage, and the call options have 0.9x leverage.  The options can never catch up to the stock.  Even better, in a bankruptcy, you lose 110% of the stock's drop in value.

I would expect to get a price somewhere between the current bid price of $12 and ask price of $17, but never lower than the current price - $1 + at least some TV. The last price was 15.38 (breakeven 16.38), and no contracts exchanged hands today. If CPE falls back below $5, the $1 strike options will be worth a decent amount more than $4.
That's a good general point, but it assumes an efficient market.  If we're talking a larger company, there's probably computer algos waiting for a profitable price, and could buy in the middle of the bid-ask spread like you mention.  But there's a lot of odd things going on with options in CPE stock expiring in 2023.

(1) No buyers.  Look at the $1 and $2 PUT options.  The bid price is $0.00 because there's nobody buying.  One last sold 2-3 days ago, the other sold 2-3 months ago.
(2) Wide bid-ask spreads, like the $12-$17/sh you mentioned (almost +50% from bid to ask).  It might be uncertainty, or a low liquidity market.
(3) Illogical moves, like yesterday's $1 call bid-ask spread of $12-17.  Today, CPE went up $1/sh (+7%), and guess what the bid-ask spread did?  It dropped $1/sh, to $11-$16/sh.  Don't trust my post - check yours and the current prices.
(4) Last trade dates.  For the call options, half of them were last traded ... last year.  If buyers and sellers were meeting in the middle, that wouldn't happen.

Which points to low liquidity, and me having to go more than halfway to make a trade.  Both of my portfolio bankruptcies were in small oil stocks like CPE, so I don't want to take advantage by selling PUT options - too risky.

The $15 strike has a +47% break even, while the $7 strike has an 18% break even (taking the worst prices) with 1.3x leverage.  I've found 1% break evens with 1.7x leverage, so this looks bad by comparison.  The only point in favor for CPE is much farther to go in a recovery.

ChpBstrd

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Re: Option prices are too high... time to sell options?
« Reply #48 on: January 14, 2021, 09:22:11 AM »
Another example of options costing too much... Callon Petroleom (CPE) options.  You could buy CPE stock at $15.44/sh, or you could buy very deep call options with a $1 strike price, expiring 2023.  The stock is a better deal in every respect.

The $1 strike options cost $17/sh.  When CPE reaches $18/sh, you break even ... but then the stock grows with 1.0x leverage, and the call options have 0.9x leverage.  The options can never catch up to the stock.  Even better, in a bankruptcy, you lose 110% of the stock's drop in value.

I would expect to get a price somewhere between the current bid price of $12 and ask price of $17, but never lower than the current price - $1 + at least some TV. The last price was 15.38 (breakeven 16.38), and no contracts exchanged hands today. If CPE falls back below $5, the $1 strike options will be worth a decent amount more than $4.
That's a good general point, but it assumes an efficient market.  If we're talking a larger company, there's probably computer algos waiting for a profitable price, and could buy in the middle of the bid-ask spread like you mention.  But there's a lot of odd things going on with options in CPE stock expiring in 2023.

(1) No buyers.  Look at the $1 and $2 PUT options.  The bid price is $0.00 because there's nobody buying.  One last sold 2-3 days ago, the other sold 2-3 months ago.
(2) Wide bid-ask spreads, like the $12-$17/sh you mentioned (almost +50% from bid to ask).  It might be uncertainty, or a low liquidity market.
(3) Illogical moves, like yesterday's $1 call bid-ask spread of $12-17.  Today, CPE went up $1/sh (+7%), and guess what the bid-ask spread did?  It dropped $1/sh, to $11-$16/sh.  Don't trust my post - check yours and the current prices.
(4) Last trade dates.  For the call options, half of them were last traded ... last year.  If buyers and sellers were meeting in the middle, that wouldn't happen.

Which points to low liquidity, and me having to go more than halfway to make a trade.  Both of my portfolio bankruptcies were in small oil stocks like CPE, so I don't want to take advantage by selling PUT options - too risky.

The $15 strike has a +47% break even, while the $7 strike has an 18% break even (taking the worst prices) with 1.3x leverage.  I've found 1% break evens with 1.7x leverage, so this looks bad by comparison.  The only point in favor for CPE is much farther to go in a recovery.

I think with illiquid markets like small cap options, the only bids that exist are "stink bids". E.g. "If someone is willing to sell me a $1 call on a $15 stock for $12, I'll take it. Or if someone is willing to buy that call for negative time value I'll sell it!" Various market players put stink bids like this all over the market, and they must occasionally catch a fish, such as when traders are forcibly liquidated or the Robinhood crowd pays the ask price. The catch to playing this game is that your computers/connections have to be super fast in order not to lose money due to a sudden movement in the stock. E.g. That $1 call you bought with your $12 stink bid is no longer a good deal one second after the stock plummets to $11. This risk is another explanation for the wide BA spreads.

We retail investors can't play this game, so we (a) cannot assume the prices we see are rational when liquidity is low - do your own math, and (b) should probably avoid illiquid markets like this, because the costs of trading is too high. Regarding (b) I've sometimes tried to sell calls or puts for illiquid ETFs at the mid range of the spread or worse, and can't get an execution. That's because it's 100% stink bids and nobody is interested in paying the mathematically fair price.

This is why SPY is more popular than VOO, despite its slightly higher ER. SPY has a more liquid options market than VOO.


MustacheAndaHalf

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Re: Option prices are too high... time to sell options?
« Reply #49 on: January 17, 2021, 09:17:21 AM »
Or see which leveraged ETFs use this more effectively?
I'm not really sure what you're asking here. Providing they are using the funds to achieve the intended results, they are all equally effective.

Most try not to constantly borrow funds. They switch funds from more leveraged assets to less leveraged assets. But eventually if they go more leveraged, they need more funds.
One of the big banks (WFC?) created their own S&P 500 fund, and did a far inferior job to Vanguard.  They didn't manage purchases and redemptions well, and realized excessive capital gains.  I already knew Vanguard uses a combination of derivatives and cash for it's last few percent of assets - that allows it to be 100% invested, but have cash for redemptions.  Either the big bank didn't know that, or handled it badly.

So it's possible for one investment company to do something worse than another, which I guess is why I wondered about ProShares vs Direxion.  Both started S&P 500 3X leveraged ETFs over a decade ago, so both have experience.  It looks like UPRO has slightly better performance - more than can be explained by the 0.1% lower expense ratio.  Mostly both seem reasonable, and I should probably be more suspect of new entrants to the leveraged ETF market.


Another example of options costing too much... Callon Petroleom (CPE) options.  You could buy CPE stock at $15.44/sh, or you could buy very deep call options with a $1 strike price, expiring 2023.  The stock is a better deal in every respect.

The $1 strike options cost $17/sh.  When CPE reaches $18/sh, you break even ... but then the stock grows with 1.0x leverage, and the call options have 0.9x leverage.  The options can never catch up to the stock.  Even better, in a bankruptcy, you lose 110% of the stock's drop in value.

I would expect to get a price somewhere between the current bid price of $12 and ask price of $17, but never lower than the current price - $1 + at least some TV. The last price was 15.38 (breakeven 16.38), and no contracts exchanged hands today. If CPE falls back below $5, the $1 strike options will be worth a decent amount more than $4.
That's a good general point, but it assumes an efficient market.  If we're talking a larger company, there's probably computer algos waiting for a profitable price, and could buy in the middle of the bid-ask spread like you mention.  But there's a lot of odd things going on with options in CPE stock expiring in 2023.

(1) No buyers.  Look at the $1 and $2 PUT options.  The bid price is $0.00 because there's nobody buying.  One last sold 2-3 days ago, the other sold 2-3 months ago.
(2) Wide bid-ask spreads, like the $12-$17/sh you mentioned (almost +50% from bid to ask).  It might be uncertainty, or a low liquidity market.
(3) Illogical moves, like yesterday's $1 call bid-ask spread of $12-17.  Today, CPE went up $1/sh (+7%), and guess what the bid-ask spread did?  It dropped $1/sh, to $11-$16/sh.  Don't trust my post - check yours and the current prices.
(4) Last trade dates.  For the call options, half of them were last traded ... last year.  If buyers and sellers were meeting in the middle, that wouldn't happen.

Which points to low liquidity, and me having to go more than halfway to make a trade.  Both of my portfolio bankruptcies were in small oil stocks like CPE, so I don't want to take advantage by selling PUT options - too risky.

The $15 strike has a +47% break even, while the $7 strike has an 18% break even (taking the worst prices) with 1.3x leverage.  I've found 1% break evens with 1.7x leverage, so this looks bad by comparison.  The only point in favor for CPE is much farther to go in a recovery.

I think with illiquid markets like small cap options, the only bids that exist are "stink bids". E.g. "If someone is willing to sell me a $1 call on a $15 stock for $12, I'll take it. Or if someone is willing to buy that call for negative time value I'll sell it!" Various market players put stink bids like this all over the market, and they must occasionally catch a fish, such as when traders are forcibly liquidated or the Robinhood crowd pays the ask price. The catch to playing this game is that your computers/connections have to be super fast in order not to lose money due to a sudden movement in the stock. E.g. That $1 call you bought with your $12 stink bid is no longer a good deal one second after the stock plummets to $11. This risk is another explanation for the wide BA spreads.

We retail investors can't play this game, so we (a) cannot assume the prices we see are rational when liquidity is low - do your own math, and (b) should probably avoid illiquid markets like this, because the costs of trading is too high. Regarding (b) I've sometimes tried to sell calls or puts for illiquid ETFs at the mid range of the spread or worse, and can't get an execution. That's because it's 100% stink bids and nobody is interested in paying the mathematically fair price.

This is why SPY is more popular than VOO, despite its slightly higher ER. SPY has a more liquid options market than VOO.
I agree trading costs are high, but sometimes I don't have a choice - if an option is likely to triple, I have to pay a few percent more to get the much larger gains.  So the algos win small, and I win big (hopefully, and so far it's been the case).

I have some in the money options that expire in March.  The bid is only 0.2% above the current stock price, which is a bit low for 2 months of time value.  Maybe I'll sell when good news pushes the time value up higher.