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Learning, Sharing, and Teaching => Investor Alley => Topic started by: Financial.Velociraptor on June 21, 2020, 10:23:32 AM
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@MustacheAndaHalf @Buffaloski Boris
By request, a primer on how to profit when options are "expensive".
I'm going to outline a favorite options strategy of mine. But first a word of warning. A lot of novice traders have blown up their accounts by using options the wrong way. You can gain an enormous amount of leverage with options. That leverage cuts both ways and is enormously harmful if the underlying moves against you. Options were not designed to be used that way. If you want to generate reliable income from options, you need to keep something in mind: you must ALWAYS design your trades to REDUCE risk.
One of my favorite strategies, and it is THE strategy for a beginner, is the "covered call". This is an income generating tactic that profits from the passage of time. (The passage of time so far has been a part of the laws of physics we can rely upon). As a quick tutorial, options premium prices have two components Intrinsic Value (IV), which is equal to amount the option is "in the money"; and Time Value, which is a variable amount determined by how much the market currently values the 'optionality' of a contract. For covered calls, we are interested in TV. When it is "large", like today when fear is rampant in the market and volatility is high, we can make an outstanding annualized return while REDUCING the risk of simply of holding shares.
Picking somewhat randomly, I'm going to give an example with Comcast (CMCSA). A hated company that is pretty good about hitting managements guidance, no matter how many customers they have to piss off to do it. I choose it partly because the share price is nominally "small" and thus represents a smaller initial cash outlay for new options investors who might have smaller accounts. Shares closed Friday at $39.10.
Each options contract controls 100 shares. Thus, you will be operating in 100 share lots. For CMCSA at 39.10, you initial outlay is thus $3,910 (less the premium you sell) to get into the trade. TV decays over time and is always zero after expiry. Decay is not linear over time and accelerates with 6-8 weeks remaining till expiry, thus we are going to target about 6-8 weeks holding period. Thus, for the example, I will use the 31JUL2020 expiry and assume you enter the trade on (tomorrow) Monday 22JUN2020.
Now a call option gives the buyer the right, but not the obligation to buy 100 shares of the underlying security for the strike price at any time up to and including expiry. As options sellers, we become the counter party and have the obligation to sell shares at the strike price. Thus, we want to already own the shares. In this case, we would open a "combo order" that simultaneously instructs our broker to buy 100 shares of CMCSA while selling one contract of a call at our directed strike and expiry. I'll use a near the money strike of 40, for simplicity's sake. CMCSA200731C00040000 closed on Friday with a most recent trade at 1.33 per share. Thus, assuming the market doesn't move on open, we would pay about $3,910 for shares while receiving proceeds of $133 for the sold call contract. Total outlay is 3,910 - 133 = 3,777 and that is the most you can conceivably lose on the trade if shares go to zero. Note that anyone who simply bought the underlying at 3,910 has 133 dollars more risk than you do; you have lowered your risk with options!
Now the 133 is yours to keep win, lose, or draw. Let's say 40 days from now, CMCSA hasn't moved a penny and still trades for 3,910. You will retain your shares with no unrealized capital gain or loss. You will also retain the 133 dollars as profit. Your yield is thus about 133/3910/40*365 or 31.04% annualized. You have trounced the long term average of the index while taking less risk. If shares fall, you still keep the 133 and 31.04% yield but also have an unrealized capital loss that reduces your return. However, you can write a covered call again for additional income! Now lets look at what happens if shares rise to 41 dollars before expiry. Your counterparty will have the right to buy your shares at 40 and immediately sell them in the market for 41 for a profit. Your shares will certainly be called away. You will sell 100 shares at 40, bringing in 4,000 in proceeds. You will also keep the 133 dollars in options premium. Your 90 cents per share short term capital gain, plus your 1.33 per share in premium represents a total of 2.23 per share in profits. Your annualized return is thus 223/3910/40*365 = 52.04%. Wow!
Now this example is typical of the market (right now). Because volatility and fear is high, you can earn outsized returns with options. In normal markets when volatility is low, I usually target a minimum expected return of 12% annualized. This gives me sufficient return to cover inevitable losses from shares that decline plus some profit. It usually makes about what the market index does over the same period but provides short term cash flow and importantly, REDUCES risk.
What is the trade off? You saw it in the example where shares were called away. You had to sell at 40 when the underlying was at 41. You gave up any additional upside above 40 buy selling time value.
Hope this helps.
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From my limited reading of options, I have the impression that the shorter the duration, the more the time decay. Just to test my knowledge so far (including reading your post), would writing a 4 week covered call be even better than a 6 week covered call?
CMCSA200717C00040000 valued at $0.93 (4 week option)
CMCSA200731C00040000 valued at $1.33 (6 week option)
6 week / 4 week = 1.5x
0.93 x 1.5 = 1.40 ... isn't this more profitable than the $1.33 over 6 weeks?
(Annualized: $1.33 x 8 = $10.64 versus 0.93 x 12 = $11.16)
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On the downside, I have all of this investment in one company (Comcast), instead of spread over many companies. So I assume I need to find a variety of companies where I can purchase 100 shares (avoiding AMZN $2675/sh and GOOG $1432/sh !).
If I sell calls too cheaply, won't I lose money over time?
I sell Comcast's profit above $40/share, and receive $133 for the covered call. Then my shares are called away and I'm left in cash: $4,000 + $133 = $4,133. If Comcast rose to $4,200 I lost ground. If I buy back in immediately, I need to find $67 somewhere to make up for the loss.
Don't markets often have really volatile months where this happens repeatedly? And I gradually lose more and more on the same stock? I have no experience with this at the month by month level, so I need someone else's experience on it.
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Thanks. @Financial.Velociraptor !! I appreciate your taking the time to type this out. I want to take some time to read and digest. I think the "heresy" threads are a great idea.
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From my limited reading of options, I have the impression that the shorter the duration, the more the time decay. Just to test my knowledge so far (including reading your post), would writing a 4 week covered call be even better than a 6 week covered call?
CMCSA200717C00040000 valued at $0.93 (4 week option)
CMCSA200731C00040000 valued at $1.33 (6 week option)
6 week / 4 week = 1.5x
0.93 x 1.5 = 1.40 ... isn't this more profitable than the $1.33 over 6 weeks?
(Annualized: $1.33 x 8 = $10.64 versus 0.93 x 12 = $11.16)
Typically, the sweet spot is 6 weeks. The current pricing for options due to COVID-19 is "irregular" at best. By your logic, the shortest term possible, e.g. 1 week, would always be best. I think if you check 1 week annualized vs 4 weeks, you will probably find longer was better. But yes, in this case you found a situation where 4 weeks is better than 6 (good eye!) That is, assuming commissions don't spoil the stew.
Also, to be considered it the probability of shares being called away, the probability is higher at 6 weeks than at 4. So that is another consideration. I usually find anywhere between 4 weeks and 8 weeks to provide "acceptable" risk/reward ratios with longer dated expiries being less of a hassle as I have to roll the trade less often. You'll find if you take the same strike a year or more out, the annualized return falls like a rock. For this reason (cp), you usually want more time value as a buyer of options and less as a seller.
Final point about duration of expiry: the standard options which expire on the 3rd Friday of the month has more liquidity and lower bid/ask spreads than the "weeklies". Tread carefully when volumes get really low.
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On the downside, I have all of this investment in one company (Comcast), instead of spread over many companies. So I assume I need to find a variety of companies where I can purchase 100 shares (avoiding AMZN $2675/sh and GOOG $1432/sh !).
If I sell calls too cheaply, won't I lose money over time?
I sell Comcast's profit above $40/share, and receive $133 for the covered call. Then my shares are called away and I'm left in cash: $4,000 + $133 = $4,133. If Comcast rose to $4,200 I lost ground. If I buy back in immediately, I need to find $67 somewhere to make up for the loss.
Don't markets often have really volatile months where this happens repeatedly? And I gradually lose more and more on the same stock? I have no experience with this at the month by month level, so I need someone else's experience on it.
Diversification:
Yes, if you have a small account size, buying a 100 shares of Google makes no sense as all your eggs are in one basket. Lots of good candidates in the $25 to $50 range exist though. No use if your portfolio is under $10k but then at such a neophyte stage, you really still need to be indexing and reading and learning.
Selling cheap is bad:
Yes, if you get a premium that is "too small" for the probability of the option going ballistic, you are the less smart party to the exchange. Efficient Market Hypothesis says the option is always "fairly" priced. That is probably less and less true as liquidity decreases and volatility increases. Note, you never "lose money" if your shares are called away at a strike above your cost basis. You collect a capital gain plus the options premium. You might have made less money than just holding the underlying but you did so with lowered risk. In the academic world of finance that is as close as you can get to a "free lunch".
My experience:
Sometimes you get called. The sort of ideal situation is the stock finishes at exactly your strike and you get called away earning both the premium and the full capital gain opportunity. If you collected 1.33 in options premium and the stock goes to 40.50, you lost out on 50 cents per share of capital gain but kept 1.33 per share in profit. That is, you are still ahead of just having bought and held. If CMCSA goes to 42.00, you sell at 40, keep the $133 premium but miss out on $200 in upside. The buy and hold investor "beat you" by $67.
You can use a free calculator: https://www.optionstrategist.com/calculators/probability to determine the statistical likelihood of having shares called away. You get the "implied volatility" in the required data box from yahoo! finance. In the case of CMCSA 40 strike and 40 days to expiry, the probability is 42%. More than half the time, you will keep your shares and live to write another covered call. The odds of the underlying being above 41.33 is a mere 32% or less than 1 in 3. Over long periods of time, repeatedly making investments that are likely to be better than the alternative 2/3 of the time is a winning strategy. In more mundane markets, your probability will be a lot better as big moves are rare when the ^VIX is "low".
If you choose to use this strategy, from time to time, you WILL get called away. I usually just shrug my shoulders and find the next trade which may be to get back into the same underlying stock at a higher cost basis. You can always monitor the price with respect to the strike and "roll" your options "up and out" to a higher strike and later expiry if threatened with being called away. This can often be done with a net credit (that is you receive more cash for capturing additional upside) but sometimes requires a net debit (putting cash into the trade) if the move upward is both large and "soon".
The goal is not necessarily to make the maximum gains possible. it is to generate short term income, while REDUCING risk. Always keep the risk reduction part in mind. It is the central reason to use options.
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This is fascinating stuff. Do you also take the other side of the table in selling puts? My understanding of that play is to sell in effect insurance against a drop in the price of an equity. So for example, using the CMCSA example, let's say I sell CMCSA#S0220D380000 with a strike price at $38.00. Last transaction was at $0.66. So I'm selling that for 100 shares or $66.00. I'm assuming I have to put up the money in the meantime up to the maximum amount I could lose or $3800. So, if the price of the stock doesn't drop below $38.00, I get to keep $66 for an annualized return of 66/3800/40*365=.1588 annualized. Plus wouldn't you get the interest on the underlying security you have to hold in the meantime such as a treasury? Probably negligible, but every little bit counts.
Not too bad of a return. Of course I'm sure it smarts when you have to cover that. But by and large people have a tendency to over-estimate and overprice downside risk.
(I like risk. I just want to be well compensated for it.)
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Thanks for sharing what you've learned about options trading.
As an aside, some people probably should not trade options. Are there some key questions people should be asked (or ask themselves) to weed out people who shouldn't even sell covered calls? For example, maybe people who fear missing out, and can't accept a return that differs from the market, would struggle. I think I'm mostly asking this for people reading the thread, but it could apply to me as well.
From the Yahoo Finance data on Comcast, the 1 week option looks more profitable than the 4 week option I mentioned. One quarter of $0.93 is $0.2325 ... but the 1 week option is selling for $0.40, which is much higher. I'm not actually trying to convince you 1 week options are better! I think I'm probably wrong, but I lack the experience and data you have to show me why. Is there a way I can look at option prices from the past? Historical data?
There's something I find strange, which might be why you avoid long-dated options. Take the case of two of the largest S&P 500 companies, but with very different performance: AAPL and JNJ. Apple gained +90% in one year, while Johnson & Johnson gained +5%. So one year out, here's what I see:
AAPL $350 now, call at $350 dated June 2021 costs $60.38 (IV 32%)
JNJ $144 now, call at $145 dated June 2021 costs $12.00 (IV 24%)
Apple's 12 month performance was stellar, but the 1 year option costs 17% of the stock price (6x leverage?). It seems likely Apple could beat that 17% break even point.
Meanwhile Johnson & Johnson has back to back +5% years, and seems unlikely to reach the option break even gain of +8%.
It looks to me like an options trader should be a seller of the JNJ call, and a buyer of the AAPL call.
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This is fascinating stuff. Do you also take the other side of the table in selling puts? My understanding of that play is to sell in effect insurance against a drop in the price of an equity. So for example, using the CMCSA example, let's say I sell CMCSA#S0220D380000 with a strike price at $38.00. Last transaction was at $0.66. So I'm selling that for 100 shares or $66.00. I'm assuming I have to put up the money in the meantime up to the maximum amount I could lose or $3800. So, if the price of the stock doesn't drop below $38.00, I get to keep $66 for an annualized return of 66/3800/40*365=.1588 annualized. Plus wouldn't you get the interest on the underlying security you have to hold in the meantime such as a treasury? Probably negligible, but every little bit counts.
Not too bad of a return. Of course I'm sure it smarts when you have to cover that. But by and large people have a tendency to over-estimate and overprice downside risk.
(I like risk. I just want to be well compensated for it.)
Yes, I frequently sell put options as well. They come in two flavors (to answer one of your other questions): cash secured, and marginable. For a cash secured put, you keep enough cash to cover the assignment - in your example 3,800 in your brokerage. For a margin put, you have less than 3,800 or even no cash in your brokerage account. Your broker will ordinarily assume 20% maintenance margin for a put. So basically, you get 5x leverage. That cuts both ways, your return is five times normal if you are "right" but you must take a margin loan at whatever the broker's lending rate is if you are "wrong".
So, in your case, not only do you make 15.8% to "stink bid" CMCSA, you have downside protection equal to the amount the strike is out of the money, plus the premium received. Going closer the money at 39 or 40 strike would have a higher annualized return (with greater "risk").
I like to write puts on stocks I want to own to lower my cost basis. Once assigned, I usually sell covered calls against the new position for more income and even lower risk.
NOTE: most brokers will let almost anyone sell covered calls. Selling puts is usually considered a higher risk bracket and may require additional approval from your broker. There are often 4 levels of options authority at a broker. Most people will never want to go higher than level 2.
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Thanks for sharing what you've learned about options trading.
As an aside, some people probably should not trade options. Are there some key questions people should be asked (or ask themselves) to weed out people who shouldn't even sell covered calls? For example, maybe people who fear missing out, and can't accept a return that differs from the market, would struggle. I think I'm mostly asking this for people reading the thread, but it could apply to me as well.
From the Yahoo Finance data on Comcast, the 1 week option looks more profitable than the 4 week option I mentioned. One quarter of $0.93 is $0.2325 ... but the 1 week option is selling for $0.40, which is much higher. I'm not actually trying to convince you 1 week options are better! I think I'm probably wrong, but I lack the experience and data you have to show me why. Is there a way I can look at option prices from the past? Historical data?
There's something I find strange, which might be why you avoid long-dated options. Take the case of two of the largest S&P 500 companies, but with very different performance: AAPL and JNJ. Apple gained +90% in one year, while Johnson & Johnson gained +5%. So one year out, here's what I see:
AAPL $350 now, call at $350 dated June 2021 costs $60.38 (IV 32%)
JNJ $144 now, call at $145 dated June 2021 costs $12.00 (IV 24%)
Apple's 12 month performance was stellar, but the 1 year option costs 17% of the stock price (6x leverage?). It seems likely Apple could beat that 17% break even point.
Meanwhile Johnson & Johnson has back to back +5% years, and seems unlikely to reach the option break even gain of +8%.
It looks to me like an options trader should be a seller of the JNJ call, and a buyer of the AAPL call.
It is a really weird scenario if weekly options are paying better on an annualized basis than 4 week ones. Could be a matter of expectations in that the "market" thinks the next week looks shaky and each additional week you go into the future the outcome becomes increasingly "certain". That is, they are fearful over short periods of time but confident over "long" periods of time.
You hit on an important concept with implied volatility varying between individual stocks. Some stocks are expected to move much more than others by the market and thus their options premiums will be "more expensive". Whether that is efficiently priced across the broad market is an exercise for the reader to determine. Note that the flipside to your findings also apply. JNJ is unlikely to be 50% lower a year from now (+/- 5% is a good range estimate). Apple could absolutely tank on weak iPhone sales, loss of IP in China, change of sentiment by apple fanbois, or other. Thus, your odds of a losing trade are higher with apple.
As far as who shouldn't trade covered calls - the strategy is very safe. If you have a gambling addiction and are likely to start selling naked calls, making large leveraged trades, etc. you should stay away. But covered calls are frequently recommended for grey haired retirees looking to maximize their income while reducing risk.
I'm not aware of a free resource to see historical options pricing data. You can probably get that with something like a bloomberg terminal (25k/year subscription fee). I sure would lose a lot of time data mining if such a resource existed.
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This is fascinating stuff. Do you also take the other side of the table in selling puts? My understanding of that play is to sell in effect insurance against a drop in the price of an equity. So for example, using the CMCSA example, let's say I sell CMCSA#S0220D380000 with a strike price at $38.00. Last transaction was at $0.66. So I'm selling that for 100 shares or $66.00. I'm assuming I have to put up the money in the meantime up to the maximum amount I could lose or $3800. So, if the price of the stock doesn't drop below $38.00, I get to keep $66 for an annualized return of 66/3800/40*365=.1588 annualized. Plus wouldn't you get the interest on the underlying security you have to hold in the meantime such as a treasury? Probably negligible, but every little bit counts.
Not too bad of a return. Of course I'm sure it smarts when you have to cover that. But by and large people have a tendency to over-estimate and overprice downside risk.
(I like risk. I just want to be well compensated for it.)
Yes, I frequently sell put options as well. They come in two flavors (to answer one of your other questions): cash secured, and marginable. For a cash secured put, you keep enough cash to cover the assignment - in your example 3,800 in your brokerage. For a margin put, you have less than 3,800 or even no cash in your brokerage account. Your broker will ordinarily assume 20% maintenance margin for a put. So basically, you get 5x leverage. That cuts both ways, your return is five times normal if you are "right" but you must take a margin loan at whatever the broker's lending rate is if you are "wrong".
So, in your case, not only do you make 15.8% to "stink bid" CMCSA, you have downside protection equal to the amount the strike is out of the money, plus the premium received. Going closer the money at 39 or 40 strike would have a higher annualized return (with greater "risk").
I like to write puts on stocks I want to own to lower my cost basis. Once assigned, I usually sell covered calls against the new position for more income and even lower risk.
NOTE: most brokers will let almost anyone sell covered calls. Selling puts is usually considered a higher risk bracket and may require additional approval from your broker. There are often 4 levels of options authority at a broker. Most people will never want to go higher than level 2.
Thank you for the detailed explanation. You lost me, though, on how you lower your cost basis by writing puts on stocks.
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I have some experience w/options and have recently started messing around with weeklies.
Options are the icing on the main portfolio cake. There are a few companies I know well and I am willing to trade around a core position.
IMO, people should not start w/options until they have a decent net worth. Also, being a nerd helps.
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This is fascinating stuff. Do you also take the other side of the table in selling puts? My understanding of that play is to sell in effect insurance against a drop in the price of an equity. So for example, using the CMCSA example, let's say I sell CMCSA#S0220D380000 with a strike price at $38.00. Last transaction was at $0.66. So I'm selling that for 100 shares or $66.00. I'm assuming I have to put up the money in the meantime up to the maximum amount I could lose or $3800. So, if the price of the stock doesn't drop below $38.00, I get to keep $66 for an annualized return of 66/3800/40*365=.1588 annualized. Plus wouldn't you get the interest on the underlying security you have to hold in the meantime such as a treasury? Probably negligible, but every little bit counts.
Not too bad of a return. Of course I'm sure it smarts when you have to cover that. But by and large people have a tendency to over-estimate and overprice downside risk.
(I like risk. I just want to be well compensated for it.)
Yes, I frequently sell put options as well. They come in two flavors (to answer one of your other questions): cash secured, and marginable. For a cash secured put, you keep enough cash to cover the assignment - in your example 3,800 in your brokerage. For a margin put, you have less than 3,800 or even no cash in your brokerage account. Your broker will ordinarily assume 20% maintenance margin for a put. So basically, you get 5x leverage. That cuts both ways, your return is five times normal if you are "right" but you must take a margin loan at whatever the broker's lending rate is if you are "wrong".
So, in your case, not only do you make 15.8% to "stink bid" CMCSA, you have downside protection equal to the amount the strike is out of the money, plus the premium received. Going closer the money at 39 or 40 strike would have a higher annualized return (with greater "risk").
I like to write puts on stocks I want to own to lower my cost basis. Once assigned, I usually sell covered calls against the new position for more income and even lower risk.
NOTE: most brokers will let almost anyone sell covered calls. Selling puts is usually considered a higher risk bracket and may require additional approval from your broker. There are often 4 levels of options authority at a broker. Most people will never want to go higher than level 2.
Thank you for the detailed explanation. You lost me, though, on how you lower your cost basis by writing puts on stocks.
The premium received for writing (selling) offsets some off the cost need to buy at the strike price.
If you are not assigned (forced to buy), then the premium is short-term capital gains tax-wise.
If you are assigned (forced to buy), then the cost basis of shares received are lowered by the amount of the premium.
Then you would only pay the capital gains on the difference between your lowered ( due to premium ) cost basis and final sale price.
My preferred stock buying method is to sell (write) a cash covered put.
Why?
The premium is small, so no major tax burden if not assigned, some small income.
The cost basis is lowered ( see above)
Formerly, the premium would offset the commissions. With low commissions, less of a consideration.
I set the strike to what I think I'd bid as a straight buy.
It locks the buy in and provides some excitement as the expiration gets closer.
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My father uses covered calls as a significant part of his investing strategy. I recall him telling me years ago that it probably adds a percent or so to his annual returns. I don't know whether he outperforms the indexes, but he's certainly a successful investor in that he built an impressive portfolio without ever having had a very high income (and FIRED long before anyone had ever heard of the term).
When I asked him back then if I should emulate his strategy, he didn't hesitate before answering; "Nah, I'm an old retired guy who has nothing better to do than spend hours watching the stock market. Just put your money in index funds and leave it alone." Interestingly, he told me a few weeks ago that now that he is in his mid-80s, he has started shifting some of his portfolio into index funds in preparation for the time when he either isn't around or isn't capable of managing his investments.
On the day after Father's day, I realize how much my father taught me (both intentionally and by example) about investing and having a healthy relationship with money. I need to be sure to say thank you the next time I talk to him.
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Thank you for the detailed explanation. You lost me, though, on how you lower your cost basis by writing puts on stocks.
The premium received for writing (selling) offsets some off the cost need to buy at the strike price.
If you are not assigned (forced to buy), then the premium is short-term capital gains tax-wise.
If you are assigned (forced to buy), then the cost basis of shares received are lowered by the amount of the premium.
Then you would only pay the capital gains on the difference between your lowered ( due to premium ) cost basis and final sale price.
My preferred stock buying method is to sell (write) a cash covered put.
Why?
The premium is small, so no major tax burden if not assigned, some small income.
The cost basis is lowered ( see above)
Formerly, the premium would offset the commissions. With low commissions, less of a consideration.
I set the strike to what I think I'd bid as a straight buy.
It locks the buy in and provides some excitement as the expiration gets closer.
Thanks for the explanation. I think I get it now. What you’re doing is almost like a limit order with a bonus. Let’s say you want to buy 100 shares of Comcast for $38.00. Instead of putting in a limit order, you sell a put with a strike price at $38.00. If the price goes to $38.00 or below, the option ends up being exercised you get your Comcast stock for $38.00 less the premium you got for selling the put. If the price doesn’t drop to $38, you get to pocket the premium. Either way, you get a little bit of a win.
Nice.
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Thank you for the detailed explanation. You lost me, though, on how you lower your cost basis by writing puts on stocks.
The premium received for writing (selling) offsets some off the cost need to buy at the strike price.
If you are not assigned (forced to buy), then the premium is short-term capital gains tax-wise.
If you are assigned (forced to buy), then the cost basis of shares received are lowered by the amount of the premium.
Then you would only pay the capital gains on the difference between your lowered ( due to premium ) cost basis and final sale price.
My preferred stock buying method is to sell (write) a cash covered put.
Why?
The premium is small, so no major tax burden if not assigned, some small income.
The cost basis is lowered ( see above)
Formerly, the premium would offset the commissions. With low commissions, less of a consideration.
I set the strike to what I think I'd bid as a straight buy.
It locks the buy in and provides some excitement as the expiration gets closer.
Thanks for the explanation. I think I get it now. What you’re doing is almost like a limit order with a bonus. Let’s say you want to buy 100 shares of Comcast for $38.00. Instead of putting in a limit order, you sell a put with a strike price at $38.00. If the price goes to $38.00 or below, the option ends up being exercised you get your Comcast stock for $38.00 less the premium you got for selling the put. If the price doesn’t drop to $38, you get to pocket the premium. Either way, you get a little bit of a win.
Nice.
"like a limit order with a bonus" -- well said, and exactly my intent.
There is pain in this method.
If you get exercised,
a) the price is by definition lower than your strike price --- oh, what could have been :-)
b) underlying stock/index price is nearly guaranteed to crater, at least in my experience.
as a buy and holder, the post buy cratering is just part of being long an stock/index.
I think of it as "Well I wanted it at the strike price, so of course it is going down from there, just like if I had bought it at the strike price as a limit order."
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If we're going to talk about the options here, shouldn't we also talk about you are down 50% YTD from options?
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If we're going to talk about the options here, shouldn't we also talk about you are down 50% YTD from options?
That's not nice.
For the record, I'm down 38%. And it isn't because of options. It is because of an ill advised short of TSLA that had no stop loss and the complete collapse of MRRL which was never optionable. My options trades are still very profitable and low risk. Without options, I'd be unretired right now.
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If we're going to talk about the options here, shouldn't we also talk about you are down 50% YTD from options?
That's not nice.
For the record, I'm down 38%. And it isn't because of options. It is because of an ill advised short of TSLA that had no stop loss and the complete collapse of MRRL which was never optionable. My options trades are still very profitable and low risk. Without options, I'd be unretired right now.
I gotcha. Wasn’t trying to be a jerk, just thought it was the options trades that caused the drawdown this year.
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I suggested the thread, so hodedofome you are free to blame me for it. I have many questions that are more important than Financial.Velociraptor's personal performance. That said, I would be curious how options performed last year (2019) versus this far more volatile year (year to date 2020).
Back in March, I bought numerous individual stocks at deep discounts, including a few penny stocks. One of those has surged above $1 on buy out rumors, and has enormous volume right now (average 1/6th of all shares trade each day). Since it's a penny stock (now over $1), I think it's a good idea to keep it's name anonymous. I can PM you if required, but I don't endorse the stock or penny stocks in general.
Since it's fully valued for me, I'd like to take advantage of the current excitement and volatility to sell call options. And since I want to sell my shares anyways, I'm fine with deep in the money call or put options. I don't want to be tied to this stock forever, so I'd prefer the July 17 options.
The stock is $1.70/share with the following data about July 17 calls:
$1.00 strike, $0.80, 150-200% implied volatility
$2.00 strike, $0.33, 200-250% implied volatility
$3.00 strike, $0.20, 250-300% implied volatility
My goal is to be called or sell, so that's not a factor. But I want to weigh the gains of each choice.
$1 strike has $0.70 intrinsic value and $0.10 time value. I collect $0.80, or 47% of the stock price.
$2 strike has no intrinsic value and $0.33 time value. The $0.33 premium is 19% of the stock price.
I'm worried that the $1 strike has so little time value ($0.10), that the $2 strike is a better choice. One month ago, the stock traded for under $1, so a sharp drop is quite possible. Actually, if Monday's gain were reversed, the $1 strike would immediately have more time value than the $2 strike. How would you weigh these choices, given I plan to sell the stock either way (no fear of being called)?
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@Financial.Velociraptor - I have another example of how shorting is really expensive... for my anonymous stock, it costs about 22% per year. And if the stock goes up, I have to "buy to close" my short position, regardless of price.
@markbike528CBX - I'm starting to agree with your uncovered put writing. If I write a put for a $3 strike, each contract involves 100 shares. My maximum loss is $3 x 100 = $300, and only if the stock goes to zero. That actually seems less risky to me than shorting the stock, which involves loan fees and unlimited upside risk until I cover.
$3 strike for NOV pays: $0.64 for CALL, $2.26 for PUT (deep in the money put)
Here's my choices. Keep in mind I feel price drops are more likely than gains:
(#1) sell a covered call for $0.64. I'll regret not selling now, but if the stock stays above $1.70 - $0.64 = $1.06, then I wind up with a profit.
(#2) sell both a covered call and a cash-backed put. I collect $2.90 in premiums, but the PUT being in the money costs me $1.30, so I only clear $1.60. That premium must cover both the loss in value of my shares, and the increasing cost of the put I've written. At $0.90/sh or higher, I have a profit.
(#3) sell shares ($1.70) locking in my gains, and write a cash-backed put. If the stock stays above $0.74/sh, I make a profit.
Least risky: sell shares now and offer a cash-backed put. I profit on increase, lose on a drop.
Most greedy: $3 straddle, where price movements are doubled: twice gain or twice the loss.
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Be very careful not to think of covered calls as a "heads I win, tails I still win" free money situation like many new options traders do.
The call premium received is always slightly less than the market's probability-weighted estimate of the stock's upside. You are selling the probability of that upside potential and there are supercomputers counting the cards so to speak on the other side of the trade. Imagine a spreadsheet of all possible future stock prices, with a percentage attached to each penny increment in price to represent the odds of that price occurring. The difference between today's price and each possible future price is multiplied by the percentage. The value of an option at any particular strike is the sum of all the positive numbers. If the stock has a 20% chance of going from 40 to 41, the 41 call can be sold for about 0.19 plus the value of the chance of it going above 41. (0.19 instead of 0.20 because your counterparties will usually only trade when you offer them a bargain).
Short puts are the inverse. You are selling insurance to a supercomputer, and the amount the computer is willing to pay is always slightly less than the probability-weighted estimate of the stock's downside.
In both cases, if your computer adversary calculates the you have made a pricing error, they will trade with you. Otherwise, they generally maintain the bid-ask spread with lightning fast speed.
That said, covered calls and short puts are good tools to do 2 things:
1) Enter a stock position by selling puts until a dip comes along and you are assigned. This is a good strategy if the annualize return on the puts is greater than your expected appreciation of the stock (because otherwise you should buy the stock before it runs away on you).
2) Exit a stock position by selling calls until you are forced to sell high. This is a good strategy if you think the stock is overpriced AND you have a plan to rebalance or spend the cash once assigned (i.e. if assigned you are not just going to buy the stock again at a higher price than you sold it.)
But as a lifestyle choice, I can speak from experience. There's nothing like selling a covered call to get $100 and to watch yourself miss out on $1,000 in gains while holding all the downside risk. Similarly, there's nothing like selling a put for $100 and being assigned the stock at a cost $1,000 over market value. It takes a lot of "wins" to make up for either scenario and over the long run the expected value of thousands of such trades is breakeven.
Time Value is no more abstract than a roll of the dice. Across the whole market it all resolves into Intrinsic Value in the long term. E.g. if you win at selling covered calls, it's because someone else lost selling short puts. There is no complicated options combo strategy that avoids the zero-net-sum nature of the market. There's no free lunch.
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I suggested the thread, so hodedofome you are free to blame me for it. I have many questions that are more important than Financial.Velociraptor's personal performance. That said, I would be curious how options performed last year (2019) versus this far more volatile year (year to date 2020).
Back in March, I bought numerous individual stocks at deep discounts, including a few penny stocks. One of those has surged above $1 on buy out rumors, and has enormous volume right now (average 1/6th of all shares trade each day). Since it's a penny stock (now over $1), I think it's a good idea to keep it's name anonymous. I can PM you if required, but I don't endorse the stock or penny stocks in general.
Since it's fully valued for me, I'd like to take advantage of the current excitement and volatility to sell call options. And since I want to sell my shares anyways, I'm fine with deep in the money call or put options. I don't want to be tied to this stock forever, so I'd prefer the July 17 options.
The stock is $1.70/share with the following data about July 17 calls:
$1.00 strike, $0.80, 150-200% implied volatility
$2.00 strike, $0.33, 200-250% implied volatility
$3.00 strike, $0.20, 250-300% implied volatility
My goal is to be called or sell, so that's not a factor. But I want to weigh the gains of each choice.
$1 strike has $0.70 intrinsic value and $0.10 time value. I collect $0.80, or 47% of the stock price.
$2 strike has no intrinsic value and $0.33 time value. The $0.33 premium is 19% of the stock price.
I'm worried that the $1 strike has so little time value ($0.10), that the $2 strike is a better choice. One month ago, the stock traded for under $1, so a sharp drop is quite possible. Actually, if Monday's gain were reversed, the $1 strike would immediately have more time value than the $2 strike. How would you weigh these choices, given I plan to sell the stock either way (no fear of being called)?
All other things being equal, implied volatility is your friend when selling options. The higher the better. With time value, you always get the most TV by being at the money. Going further in or out of the money always lowers your TV as a percentage of the underlying. Thus, 2 is "better" from a return perspective. That is pure mathematics and doesn't account for the possibility of being left holding at a price under a dollar when you intended to sell.
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Be very careful not to think of covered calls as a "heads I win, tails I still win" free money situation like many new options traders do.
The call premium received is always slightly less than the market's probability-weighted estimate of the stock's upside. You are selling the probability of that upside potential and there are supercomputers counting the cards so to speak on the other side of the trade.
@ChpBstrd makes a good point about the market likely being "efficient" for stocks/options with deep liquidity. In that scenario, the only way to "win" would be if the markets estimate for volatility is too high at the time you sell. I like to think that there is *always* a non-zero amount of both fear and greed in the market causing vol to be perpetually overstated. The overstatement is probably "small" as the supercomputers noted by ChpBstrd would always be hard at work trying to arbitrage that away. CBOE research seems to agree with that as they have found through extensive back testing that writing covered calls 2% out of the money yield a small amount of consistent out-performance vis-a-vis buy and hold.
I'd also note that the options price includes not just the pure statistical probability of assignment but is also driven by interest rates. You are in effect, earning interest with your sale.
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I like taking the opposite approach of @FinancialVelociraptor and either buying puts or using long calls instead of long stock positions. With a protected put, calls & cash, or collar strategy, I pay some premium in exchange for leveraged downside protection. It's like buying homeowner's insurance to ensure your portfolio does not burn down. Because sequence of returns risk in the years before/after retirement is my main concern, I want to set up a returns function with limited downside. E.g. with a protective put or cash & calls strategy, my returns hit a floor if the market does poorly. So if the market drops 40%, I might only be down 20%.
Setting downside limits like this is the essence of SORR control. People traditionally did this by having a large bond allocation, but with yields in the 0-2% range, I just can't. Paying a 3-4% per year premium to the options market to protect a 95% stock allocation provides both more definitive protection and more upside than a large 2% yielding bond allocation (bonds which would collapse double-digits if inflation increased or mass downgrades occurred). I've found that a portfolio of about 95% stocks, 5% long puts/collars has the volatility of a 60/40 or 50/50 portfolio.
There's also an algorithmic strategy here. If the market goes into correction, and I'm in a protected put or collar strategy, I can always switch to a 100% long strategy as the market falls. I do this by selling my highly appreciate puts and buying stock with he proceeds. Similarly, if I'm holding cash and a few long calls, I only lost the value of the calls and all my cash is available to deploy, hopefully near the bottom. Volatility increases options prices. You buy your puts and calls when the VIX is low, and you sell the puts when VIX is high. When stock prices recover and VIX is low again, you re-enter the hedged strategy. Thus, you are relying on real-time signals to operate the strategy, not guesses about future returns.
An IPS should be used to maintain discipline here and YOU HAVE TO STICK TO THE IPS or you'll miss the benefit like I did in March when I held back and didn't go all in at 20% down because I thought the market had farther to fall! My IPS says to drop my hedges and go all long when the market is down 20%. Why 20%? Because this is a fairly common correction, it is substantial enough to represent SORR, and the historical returns after 20% corrections are almost always positive.
Some look at the drag compared to a 100% stock portfolio, but I see it as a substitute for a bond tent with a higher expected yield. Plus, I've set up a situation where I'm invested in stocks, but market outcomes cannot possibly wipe me out, blow up my portfolio, or set back my retirement 5-10 years. That's what everyone says they want, and it's available for the taking.
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ChpBstrd - Your long call strategy is interesting, but I'm not ready for it. I need to read up on bankroll management and bet sizes (from poker) first. I agree traders, HFT and even AI stock trading are ruthlessly efficient enemies. Lucky I'm in the children's play area, where my problem is too few options being traded.
Financial.Velociraptor - For call options out of the money, isn't the premium equal to the time value? Conversely, call options in the money can have their profit subtracted from the premium - I'm assuming that's also the time value? I take those values in a spreadsheet, divide by the stock price, and that's my version of time value (as a percentage of the stock). I want the highest time value per month.
Take the example of a $1.60 stock and selling a call at $2 strike, and deciding which month:
JUL premium $0.32 (1 month away)
AUG premium $0.48 (2 months away)
NOV premium $0.64 (5 months away)
What I see is +20% first month, +10% next month, and +3.3% for each of 3 months after that. If I aim for 6% per month, then I'd reject NOV and find either JUL or AUG a good deal. Am I looking at time value wrong in this example? That's what I'm doing in practice, with a new spreadsheet I created... with option matrix premiums entered by hand. :P
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This topic is very much what I've been investigating lately. Thanks for posting.
1. Do you use any software or calculators to help you determine Delta and other option greeks? Is everything done in Excel?
2. What process do you go through to determine if a name is worthy of your time?
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Financial.Velociraptor - For call options out of the money, isn't the premium equal to the time value? Conversely, call options in the money can have their profit subtracted from the premium - I'm assuming that's also the time value? I take those values in a spreadsheet, divide by the stock price, and that's my version of time value (as a percentage of the stock). I want the highest time value per month.
Take the example of a $1.60 stock and selling a call at $2 strike, and deciding which month:
JUL premium $0.32 (1 month away)
AUG premium $0.48 (2 months away)
NOV premium $0.64 (5 months away)
What I see is +20% first month, +10% next month, and +3.3% for each of 3 months after that. If I aim for 6% per month, then I'd reject NOV and find either JUL or AUG a good deal. Am I looking at time value wrong in this example? That's what I'm doing in practice, with a new spreadsheet I created... with option matrix premiums entered by hand. :P
IV is also equal to the amount the option is in the money. TV is always total premium less IV. So out of the money calls/ puts are always 100% IV as you noted.
Your annualized return will ordinarily rise as your expiry date gets closer to the current date (but usually with a floor around 6-8 weeks out). Your matrix is right, the further out your go into AUG, NOV, etc, your annualized return will continue to fall. This assumes a "contango" state.
Contango - This is defined by premiums for options or futures that get higher the further out the expiry. In normal situations, TV increases as you "buy more time". With futures for commodity markets and some other markets, future expectations sometimes move such that the nearer expiry is more expensive (known as "backwardation")
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I like taking the opposite approach of @FinancialVelociraptor and either buying puts or using long calls instead of long stock positions. With a protected put, calls & cash, or collar strategy, I pay some premium in exchange for leveraged downside protection. It's like buying homeowner's insurance to ensure your portfolio does not burn down. Because sequence of returns risk in the years before/after retirement is my main concern, I want to set up a returns function with limited downside. E.g. with a protective put or cash & calls strategy, my returns hit a floor if the market does poorly. So if the market drops 40%, I might only be down 20%.
Setting downside limits like this is the essence of SORR control. People traditionally did this by having a large bond allocation, but with yields in the 0-2% range, I just can't. Paying a 3-4% per year premium to the options market to protect a 95% stock allocation provides both more definitive protection and more upside than a large 2% yielding bond allocation (bonds which would collapse double-digits if inflation increased or mass downgrades occurred). I've found that a portfolio of about 95% stocks, 5% long puts/collars has the volatility of a 60/40 or 50/50 portfolio.
There's also an algorithmic strategy here. If the market goes into correction, and I'm in a protected put or collar strategy, I can always switch to a 100% long strategy as the market falls. I do this by selling my highly appreciate puts and buying stock with he proceeds. Similarly, if I'm holding cash and a few long calls, I only lost the value of the calls and all my cash is available to deploy, hopefully near the bottom. Volatility increases options prices. You buy your puts and calls when the VIX is low, and you sell the puts when VIX is high. When stock prices recover and VIX is low again, you re-enter the hedged strategy. Thus, you are relying on real-time signals to operate the strategy, not guesses about future returns.
An IPS should be used to maintain discipline here and YOU HAVE TO STICK TO THE IPS or you'll miss the benefit like I did in March when I held back and didn't go all in at 20% down because I thought the market had farther to fall! My IPS says to drop my hedges and go all long when the market is down 20%. Why 20%? Because this is a fairly common correction, it is substantial enough to represent SORR, and the historical returns after 20% corrections are almost always positive.
Some look at the drag compared to a 100% stock portfolio, but I see it as a substitute for a bond tent with a higher expected yield. Plus, I've set up a situation where I'm invested in stocks, but market outcomes cannot possibly wipe me out, blow up my portfolio, or set back my retirement 5-10 years. That's what everyone says they want, and it's available for the taking.
Interesting idea. I like closed end municipal bond funds for my taxable bond allocation. Paying over 4.5% tax exempt right now assuming you stick to the quality funds and don't go balls out for riskier yield.
Starting early last year, I started buying long dated puts on names I thought were over leveraged, especially if they had declining sales. Theory was in a widespread market panic, the overly leveraged names will fall first and farthest, including to zero. I made good money on HTZ, GM, UBER, JWN, COP, DDS, CAKE, RIG, ALLY, F, while losing on PTON, T, and MCK. With my TSLA short oopsie and complete loss of MRRL when it folded, these hedges literally saved my portfolio. I still hold puts on DRI, LYFT, PLAY, UBER, XOM, DAL, and RAD. All but LYFT and RAD are underwater with the market rally. I'm down a total of 1,018 at market which is something I'm willing to pay for "insurance" that could pay off big if the market tanks 50% again.
"Cash and calls" is a tried and true method.
I also like "diagonal calls" in times of market stability. Buy a long dated deep in the money call to minimize time value. This gives you leveraged to the underlying while reducing your capital at risk. You can use the long call to hedge short dated out of the money short calls. Your return is only a few percent annualized (notional) but is leveraged and you retain the upside of share appreciation.
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Note to all: This is one of the more fascinating topics I've seen here on MMM. Thanks for the posts and the willingness to teach.
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Note to all: This is one of the more fascinating topics I've seen here on MMM. Thanks for the posts and the willingness to teach.
@Buffaloski Boris @MustacheAndaHalf
How far down this rabbit hole do we want to go? Should I discuss how to buy a net debit spread, particularly how I like to structure such trades for high probability of profit? That strategy is more advanced and might not be available to new options traders at some brokers. It will be at least a "level 2" of trading permissions, maybe 3.
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I'd prefer going slowly, myself. In March/April I covered a lot of ground, going from passive investor to market timer buying dozens of individual stocks. It's likely once COVID is over, I will revert back to a mostly passive investor, with a standard US/international/bond allocation. But in all this excitement, I think it's prudent I have a chunk of "play money" that I can experiment on, to keep me away from meddling with my main portfolio.
Let's say I'm like most of MMM back in 2019, and I have a total stock market ETF, a total international ETF, and a bond allocation. Is there something small and low risk they could do that provides a small but very reliable return? Or is that a dangerous way to get into options, by not seeing the risks?
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Take the example of a $1.60 stock and selling a call at $2 strike, and deciding which month:
JUL premium $0.32 (1 month away)
AUG premium $0.48 (2 months away)
NOV premium $0.64 (5 months away)
What I see is +20% first month, +10% next month, and +3.3% for each of 3 months after that.
IV is also equal to the amount the option is in the money. TV is always total premium less IV. So out of the money calls/ puts are always 100% IV as you noted.
Your annualized return will ordinarily rise as your expiry date gets closer to the current date (but usually with a floor around 6-8 weeks out). Your matrix is right, the further out your go into AUG, NOV, etc, your annualized return will continue to fall. This assumes a "contango" state.
Thanks for the confirmation - saying what I think is accurate is one thing, having it confirmed another. I should probably ask more definition and tools questions, and less strategy questions right now.
Looks like I need to open up Interactive Broker's "Option Trader" window/program and view the option chain / matrix using that. It was really annoying stepping through each possible date and strike price to collect information at Vanguard! That will make it less frustrating than my first day option trading.
I wrote $2 calls for JUL and AUG when the stock was $1.60/sh, so I collected $20 per contract ($0.20/sh x 100 sh/contract = $20/contract). I also have evidence I'm not dealing with professional traders: I got a partial execution of one $60 contract, and only 20-30 minutes later were the other contracts purchased. Right now I don't need to worry about "bet sizes", because I'm dealing with contracts worth $20 to $90 for 100 shares.
@ChpBstrd - You mentioned supercomputers.. maybe I'll just say "HFT" (high frequency trading) because it's short and conveys a reasonably accurate meaning. When I trade options at Vanguard, I'm required to price options to the nearest $0.05 (for amounts under $3). Am I at a disadvantage? Is everyone playing by that rule, or can traders buy/sell in $0.01 increments?
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Is there something small and low risk they could do that provides a small but very reliable return? Or is that a dangerous way to get into options, by not seeing the risks?
Deep in the money net debit spreads fit that bill. Very high probability of success. Return 'small'.
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Here is a warning for inexperienced investors not to get in over their heads
https://www.cnn.com/2020/06/19/business/robinhood-suicide-alex-kearns/index.html
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I'd prefer going slowly, myself. In March/April I covered a lot of ground, going from passive investor to market timer buying dozens of individual stocks. It's likely once COVID is over, I will revert back to a mostly passive investor, with a standard US/international/bond allocation. But in all this excitement, I think it's prudent I have a chunk of "play money" that I can experiment on, to keep me away from meddling with my main portfolio.
Let's say I'm like most of MMM back in 2019, and I have a total stock market ETF, a total international ETF, and a bond allocation. Is there something small and low risk they could do that provides a small but very reliable return? Or is that a dangerous way to get into options, by not seeing the risks?
Pretty much dittoes for me. I want to go play first before I get into the more complex stuff. Might we have you back for a topic on advanced heresy later?
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Pretty much dittoes for me. I want to go play first before I get into the more complex stuff. Might we have you back for a topic on advanced heresy later?
"Advanced heresy" when appropriate, sounds like a lot of fun. I'm in.
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Here is a warning for inexperienced investors not to get in over their heads
https://www.cnn.com/2020/06/19/business/robinhood-suicide-alex-kearns/index.html
Right, take it slow, and just don't be afraid to lose out on an opportunity when your still learning the ropes. Options can be profitable, as Financial.Velociraptor has stated, but make sure you understand all risks before playing the game. No one here wants to see that type of thing happen to anyone here!
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Here is a warning for inexperienced investors not to get in over their heads
https://www.cnn.com/2020/06/19/business/robinhood-suicide-alex-kearns/index.html
A 20 year old saw a $-700,000 balance and killed themselves over it. But the balance was temporary per transactions that hadn't settled, so he misunderstood the situation. He could have asked what it meant, and not killed himself. Or he could have declared bankruptcy and not killed himself. As a moral warning, it kinda falls apart when examined closely. But maybe it's worth talking about investment risk.
I'm fine with removing the most risky moves from discussion: margin loans (aka "leverage"), uncovered calls (buying a stock regardless of price), selling stock short (paying for unlimited upside). I think those are the only ways where a smaller investment can wipe out an entire account. Did I miss any? I'm okay leaving those out of the discussion - to limit the risk of the approaches discussed here.
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I'd prefer going slowly, myself. In March/April I covered a lot of ground, going from passive investor to market timer buying dozens of individual stocks. It's likely once COVID is over, I will revert back to a mostly passive investor, with a standard US/international/bond allocation. But in all this excitement, I think it's prudent I have a chunk of "play money" that I can experiment on, to keep me away from meddling with my main portfolio.
Let's say I'm like most of MMM back in 2019, and I have a total stock market ETF, a total international ETF, and a bond allocation. Is there something small and low risk they could do that provides a small but very reliable return? Or is that a dangerous way to get into options, by not seeing the risks?
Pretty much dittoes for me. I want to go play first before I get into the more complex stuff. Might we have you back for a topic on advanced heresy later?
Just remember 2 things:
1) When you buy an option, your maximum loss is 100% of the amount spent. Luckily, you don’t have to spend much in normal circumstances to buy a lot of leverage.
2) When you sell an option, your maximum losses can go astronomical. For short calls, the possible losses are theoretically infinity minus premium received. For short puts, the possible losses are the entire strike price, minus premium received.
You cannot possibly “blow up” your portfolio buying small amounts of options. Of course your portfolio could hit 100% losses if you went “all in”, but there’s no need to get that greedy because you’re already working with leverage. Selling is a whole other ballgame, where a seemingly small position can lose a lot more. Usually your broker will set some guardrails around naked selling, e.g. selling a call without owning the stock to be called away.
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@Financial.Velociraptor,
Ive been trying to work out how to do this on DEGIRO for a long time and no further forward. Seem to have limits on what I can choose.
Ever considering showing this on a youtube?
Will need to digest this thread.....very good and thanks
baz
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... But maybe it's worth talking about investment risk.
I'm fine with removing the most risky moves from discussion: margin loans (aka "leverage"), uncovered calls (buying a stock regardless of price), selling stock short (paying for unlimited upside). I think those are the only ways where a smaller investment can wipe out an entire account. Did I miss any? I'm okay leaving those out of the discussion - to limit the risk of the approaches discussed here.
Probably did, but, I believe those are the main big ones. And yea best to leave those out, but also good to point those out as existing, in case someone interested in this "heresy" comes along and isn't aware of them.
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... But maybe it's worth talking about investment risk.
I'm fine with removing the most risky moves from discussion: margin loans (aka "leverage"), uncovered calls (buying a stock regardless of price), selling stock short (paying for unlimited upside). I think those are the only ways where a smaller investment can wipe out an entire account. Did I miss any? I'm okay leaving those out of the discussion - to limit the risk of the approaches discussed here.
Probably did, but, I believe those are the main big ones. And yea best to leave those out, but also good to point those out as existing, in case someone interested in this "heresy" comes along and isn't aware of them.
Selling a put has a risk profile of the entire strike price minus premium received. So if I sell a put at a $35 strike for $0.50, and then the scandal breaks and the stock goes to $0.50, I just lost $34.00 on a $0.50 trade. I'd call that a blowup.
Credit spreads and other multi-leg strategies can also generate losses many times in excess of premium received.
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@Financial.Velociraptor,
Ive been trying to work out how to do this on DEGIRO for a long time and no further forward. Seem to have limits on what I can choose.
Ever considering showing this on a youtube?
Will need to digest this thread.....very good and thanks
baz
Baz,
I don't follow. What is DEGIRO?
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bthewalls - Have you signed an "options agreement" with your broker? In the U.S., you have to list years of experience in various areas (stocks, bonds, options) and how many trades you make per year, and the value of each trade. I did not have access to option trades until my broker approved me for it.
ChpBstrd - I wrote/sold some cash covered puts this week, but at a $1 strike price. My maximum loss is $-100 per contract, and I was paid $30 to $40 each to take on that risk for whoever bought the put option. Going forward, I probably won't use cash covered puts on other stocks.
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I'm thinking of replacing one deeply discounted stock with long-dated call options. So I would sell the stock, buy equivalent call options, and free up some cash. But I would need to have that cash available later for "rolling forward"? Meaning when Jan 2022 gets closer, I sell my call and purchase longer-dated options - I would pay a premium for that, which eats into the cash I set aside earlier.
If COVID-19 ends by Jan 2022, the strategy frees up cash and has the same profit. But if I wait for mid-2021 and nothing changes, I'll need to replace my Jan 2022 calls with Jan 2023 (or so). I'll need to pay the price difference between selling my call option to someone else, and buying a new call option. Is that roughly the right idea and terminology?
A long-dated call:
(1) Frees up cash up front, or can be used to add leverage
(2) As time passes, "roll forward" costs are needed to keep the call active. I replace the old calls by new ones.
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I'm thinking of replacing one deeply discounted stock with long-dated call options. So I would sell the stock, buy equivalent call options, and free up some cash. But I would need to have that cash available later for "rolling forward"? Meaning when Jan 2022 gets closer, I sell my call and purchase longer-dated options - I would pay a premium for that, which eats into the cash I set aside earlier.
If COVID-19 ends by Jan 2022, the strategy frees up cash and has the same profit. But if I wait for mid-2021 and nothing changes, I'll need to replace my Jan 2022 calls with Jan 2023 (or so). I'll need to pay the price difference between selling my call option to someone else, and buying a new call option. Is that roughly the right idea and terminology?
A long-dated call:
(1) Frees up cash up front, or can be used to add leverage
(2) As time passes, "roll forward" costs are needed to keep the call active. I replace the old calls by new ones.
Yes, that’s a good synopsis of cash & calls, played long term. Note, however that buy & hold will outperform cash & calls if the market is flat. With calls & cash, you lose the entire time value in a flat market. With buy & hold, your return would be only zero instead of negative.
Your long call could also lose value if volatility decreases. I don’t think now is the ideal time to enter positions involving a long option. The reason is that volatility is still historically high. VIX is in the 30s instead of the teens. That means options are more expensive than usual, and with less upside potential due to volatility. The ideal time to buy into a protected put or cash & calls strategy is when prices and high and volatility is low, like VIX < 15.
If you need a limited-risk place to put money today, consider a collar strategy, which is a combination of a protective put and a covered call. The short call pays for the long put. If you buy a put and sell a call at a net price near zero, you are hedged against falling or rising volatility. You are volatility neutral as they say. Note that you are also time decay neutral!
The payoff structure allows for limited gains and limited losses. This is hardly a time to take big risks or get greedy so the collar strategy may be the perfect way to control SORR while catching some stock market upside if it occurs. E.g. you could set up a collar so your returns can only be somewhere between 10% and -10% in a year, and still spend about 100% of your stock allocation on stocks.
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ChpBstrd - I'm glad I'm using those terms right, and understanding one of the trade offs. I did not think about the impact of option pricing on volatility, I'll try and internalize that.
I should explain why I don't want to sell covered calls on my individual stock picks. I bought individual stocks like DIN, M, DXPE back in late March at discounts -67% or more, meaning these stocks could triple in a recovery. Take Dine Brands (DIN $41.27) with a 52 week high of $104.47. If DIN recovered tomorrow to it's 52 week high, it more than doubles. Macy's would more than triple, and so on. I don't want to sell covered calls because I'm waiting for their recovery, which could be dramatic.
I want to understand roll costs, where it looks to me like stock price and time are both factors in option pricing. Looking at the options chain for for Macy's stock (NYSE:M @ $6.50):
https://finance.yahoo.com/quote/M/options?p=M
Call options for Macy's (M $6.50) with strike price of $6 ... and then $7:
July 17 2020: 0.92 ... 0.46 (imply volat 104% ... 107%)
Aug 21 2020: 1.23 ... 0.83 (imply volat 97% ... 100%)
...
Jan 15 2021: 1.92 ... 1.54 (imply volat 90% ... 91%)
Feb 19 2021: 2.00 ... 1.62 (imply volat 102% ... 86%)
For the Macy's $7 call options, the Aug option costs +80% compared to the July option, which is a very steep roll forward. For the 2021 options, Jan costs just +5% to roll into Feb. (For the $8 strike, it costs about 5.4% per month to roll forward a year - but there's no $6 or $7 options for 2022).
The Macy's $6 call options are cheaper to roll forward, +34% for July to Aug, and +4.2% for Jan to Feb. What should I learn from that?
And also, is a 4% to 5% long-term roll forward cost reasonable, or is it much higher owing to volatility?
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I think all options investors need to choose their underlying stocks carefully. I trade options on stocks where I have decent knowledge about the company and I trade around long portfolio positions. Quality long positions are the foundation of my investing.
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My latest options shenanigan:
I got into NLY with a short 6 strike put on 16MAY2020. I have since been writing 6.5 strike covered calls. I had one that was expiring in the money tomorrow. Yesterday, I rolled out to 31JULY2020 (same strike.) Why? NLY goes ex-div on Monday. By rolling my expiry, I should have enough time value on Monday to avoid assignment and collect the 22 cent divvy. As a bonus, the roll created a net credit of 12 cents (19.73% annualized return). I did take a short term loss on closing the old call as it was deeper in the money than my original premium. But the replacement had high nominal premium b/c it was similarly in the money.
Assuming I collect the distribution and have shares called away in late July, my return for the roll, all things considered will be 138.11% annualized.
Honestly, I'm hopeful for a slight pullback by then so I can roll again but "up and out" to the 7 strike to keep shares and continue writing calls at a higher strike with more unrealized cap gains in my back pocket. NLY has treated me very well and is up 33% (almost 37 assuming I collect the distribution on Monday) since just mid May. I just wish I had the stones to buy when it was in the dumpster at 3.51!
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@Financial.Velociraptor,
Ive been trying to work out how to do this on DEGIRO for a long time and no further forward. Seem to have limits on what I can choose.
Ever considering showing this on a youtube?
Will need to digest this thread.....very good and thanks
baz
Baz,
I don't follow. What is DEGIRO?
Degiro a trading platform Like an app
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@Financial.Velociraptor - Knowing what you know now, how would you approach TSLA?
I don't know the company's full story, but roughly speaking they are exclusively an electric car maker with long battery range. A new factory in China suggests they'll make inroads to the Chinese market, while also being closer to a key ingredient in batteries (rare earths in China). Tesla fans aren't looking at P/E when they buy the stock.
Tesla is priced for exponential growth, which strikes me as a good thing to bet against (unless it's COVID!). China has not respected intellectual property (IP) in the past, so Tesla's battery plans could leak to Chinese car makers. Ford plans on making an all-electric truck that could prove much more popular than Tesla's. Any one event is unlikely, but Tesla perfectly dodging them all seems unlikely, too.
Buying 11.5 month PUT options on Tesla with $1000 strike costs about $250/sh, or $25,000/contract. If Tesla falls -22% that PUT only breaks even! Similarly for 2 years out costing $336/sh, or $33,600/contract, which requires Tesla fall -31% in two years to break even. I like the idea of stock options, but not the prices.
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@Financial.Velociraptor - Knowing what you know now, how would you approach TSLA?
I don't know the company's full story, but roughly speaking they are exclusively an electric car maker with long battery range. A new factory in China suggests they'll make inroads to the Chinese market, while also being closer to a key ingredient in batteries (rare earths in China). Tesla fans aren't looking at P/E when they buy the stock.
Tesla is priced for exponential growth, which strikes me as a good thing to bet against (unless it's COVID!). China has not respected intellectual property (IP) in the past, so Tesla's battery plans could leak to Chinese car makers. Ford plans on making an all-electric truck that could prove much more popular than Tesla's. Any one event is unlikely, but Tesla perfectly dodging them all seems unlikely, too.
Buying 11.5 month PUT options on Tesla with $1000 strike costs about $250/sh, or $25,000/contract. If Tesla falls -22% that PUT only breaks even! Similarly for 2 years out costing $336/sh, or $33,600/contract, which requires Tesla fall -31% in two years to break even. I like the idea of stock options, but not the prices.
It isn't a good idea to bet against a stock with a cult following. Especially at those prices!
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I wasn't asked, but here're my thoughts anyway :). You write puts on companies/funds you want to own long-term, but only at a discount, and you bet against companies that have problems you don't think are reflected in the price. IDK if Tesla fits either bill for me.
TSLA is a company a lot of people want to own long-term, but its price is 100% speculation, so it is difficult to establish a price that would be a discount. How much does cheap FOMO cost? At what point would lowered expectations be a bargain? If the goal is to buy hype low and sell hype high, at what level is hype low, and relative to what else?
If I did anything with TSLA, I might do an in-the-money bear spread. TSLA's high volatility means the pricing of options across strikes is compressed. I.e. the 1000 call or put is not priced much differently than the 1005 call or put, and it is this way up and down the chain. This means that spreads are relatively cheap. I'd go the bear route to hedge my market exposure elsewhere. The 1095/1100 call spread with 32 days left on it could be had for a credit of about $138 with a maximum $500-138=$362 at risk. TSLA would have to rally $99.38 (almost 10%) in 32d for this trade to break even. Yes, this outcome happens all the time with TSLA but the 50% upside seems fair to me, particularly if I'm partially offsetting the risk of an overall market fall affecting other investments.
If you want to get really fancy, offset the risk of this bear call spread with credit received from a bull put spread (i.e. do a "condor"). The 895/900 bull put spread could be had for a credit of about 177 with $500-177=323 at risk. TSLA would have to fall >10% for this spread to lose money. Put the credits together and the most you can lose is 500-138-177=185, or 185/500=37% of the money at risk (500 at risk instead of 1000 because TSLA cannot both go up 10% and down 10% on the expiration date) and there's a good chance you would earn $315, or 63% in 32 days.
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(Having several more experienced option traders helping is fine by me!)
I have dual views of Tesla... could go up +50% or down -50%, so maybe a bull spread this time.
https://www.investopedia.com/terms/b/bullspread.asp
Tesla (TSLA) closed at $1009.35 on Monday (June 29). This pair of July 17 calls are fresh (last min Mon):
$1010 strike, $62.10 premium
$1030 strike, $54.00 premium
If TSLA falls or goes nowhere, my plan is a -100% loss of the difference ($8.10 x 100 shares = $810). If TSLA equals it's worst historical performance (5 yr, +31%), the trade profits +42%. And if Tesla continues like any of the recent data shows (+5% Monday, +20% last month), the stock hits $1030 and closes the spread, paying +147% profit. COVID-19 adds to the risk.
So I think I'd want to: (1) buy a $1010 call; and (2) sell a $1030 call. I'm guessing I can do that more easily at Interactive Brokers (both as one operation) than Vanguard. Vanguard might not allow a "covered call" when I have an option, not the stock.
Is there a way to tie the two together? Meaning if someone exercises the $1030 call, I want to automatically exercise my $1010 call to pay for it.
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(Having several more experienced option traders helping is fine by me!)
I have dual views of Tesla... could go up +50% or down -50%, so maybe a bull spread this time.
https://www.investopedia.com/terms/b/bullspread.asp
Tesla (TSLA) closed at $1009.35 on Monday (June 29). This pair of July 17 calls are fresh (last min Mon):
$1010 strike, $62.10 premium
$1030 strike, $54.00 premium
If TSLA falls or goes nowhere, my plan is a -100% loss of the difference ($8.10 x 100 shares = $810). If TSLA equals it's worst historical performance (5 yr, +31%), the trade profits +42%. And if Tesla continues like any of the recent data shows (+5% Monday, +20% last month), the stock hits $1030 and closes the spread, paying +147% profit. COVID-19 adds to the risk.
So I think I'd want to: (1) buy a $1010 call; and (2) sell a $1030 call. I'm guessing I can do that more easily at Interactive Brokers (both as one operation) than Vanguard. Vanguard might not allow a "covered call" when I have an option, not the stock.
Is there a way to tie the two together? Meaning if someone exercises the $1030 call, I want to automatically exercise my $1010 call to pay for it.
I'm not familiar with Vanguard, but I think on most platforms a spread is entered as one trade. You might want to use their website instead of their mobile app, particularly if you want to set up a contingency order. Also, some platforms have a simple mobile app and a complex mobile app with more features like options strategies.
If you don't have the right buttons, check the options trading level at which you are authorized. Level 1 means you can only buy options and maybe do covered calls. Spreads are a higher level of complexity. It can take a couple of days to obtain the required permissions.
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"I'd like to share a revelation that I've had during my time here" - Agent Smith, The Matrix
A call option can be viewed as owning stock for a cheaper price. For example:
(HOLD) pays $1090 for TSLA now, and holds it 1 year
(OPTION) pays $604 for a deep in the money call at $495/sh
Let's say OPTION takes a -100% loss because TSLA drops to $495/share... OPTION lost $604.
But HOLD owned $1090 of stock, now worth $495... they lost $595. Both lost about $600... it's not a "-100% loss", but about the same loss to the option holder or stock holder.
A year ago TSLA's stock price was $233. If TSLA sunk back to it's 52 week low, OPTION still lost $604... but HOLD lost $857. So while there's still a question of what happens when options are set to expire, at least now I see how options can be a cheaper way to own stock.
https://www.investopedia.com/articles/optioninvestor/06/options4advantages.asp
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...
If TSLA falls or goes nowhere, my plan is a -100% loss of the difference ($8.10 x 100 shares = $810). If TSLA equals it's worst historical performance (5 yr, +31%), the trade profits +42%. And if Tesla continues like any of the recent data shows (+5% Monday, +20% last month), the stock hits $1030 and closes the spread, paying +147% profit. COVID-19 adds to the risk.
So I think I'd want to: (1) buy a $1010 call; and (2) sell a $1030 call. I'm guessing I can do that more easily at Interactive Brokers (both as one operation) than Vanguard. Vanguard might not allow a "covered call" when I have an option, not the stock.
Is there a way to tie the two together? Meaning if someone exercises the $1030 call, I want to automatically exercise my $1010 call to pay for it.
I'm not familiar with Vanguard, but I think on most platforms a spread is entered as one trade. You might want to use their website instead of their mobile app, particularly if you want to set up a contingency order. Also, some platforms have a simple mobile app and a complex mobile app with more features like options strategies.
If you don't have the right buttons, check the options trading level at which you are authorized. Level 1 means you can only buy options and maybe do covered calls. Spreads are a higher level of complexity. It can take a couple of days to obtain the required permissions.
At Vanguard I did not request the higher level initially, so maybe I should do that to see if their interface changes. I believe Interactive Brokers has put far more effort into their trading interface.
(As to the paper trade I mentioned, it would have been +147% profitable since TSLA went up 6% today, passing up $1030/sh. Maybe next time).
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A 1010/1030 BCS puts $2,000 in capital at risk.
I'm not aware of an "automatically exercise [long], if [short] assigned" feature at any broker. I'd lay odds if you are decent programmer, you could get IB's "Trader Work Station" to automate that though. I use IB. IB will automatically start liquidating positions if you have a margin violation (they don't do margin calls). From experience, the algorithm, is coded to liquidate your positions in the least tax efficient manner possible. PROTIP: don't have a margin violation.
But if you get your short leg assigned, by definition the long leg is still "in the money". So you are hedged and your margin requirement is [small]. Theoretically, you want to set up a combo order if assigned to buy back the short shares while selling the long call. This theoretically recovers some of the remaining time value and yields a bonus profit. Might actually even work on TSLA where liquidity is high. I've found when spreads get assigned early, I can't get the market maker to give up the time value that should rightfully be mine with a combo order. At any rate, early assignment usually means the TV remaining was already [low]. I've just made it a policy to log in and exercise my long call. There is no commission at IB that way so even if I could extract some time value the commissions would cut into it.
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Vanguard does not do multi leg trades. You can look at IB or Tastytrade if you want that. I have been happy enough swimming in the kiddie pool there.
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Thinkorswim apps from TD Ameritrade are another pro-level choice. The desktop app is enthusiast level - expect to invest 100 hours figuring out half of what it does. It's as close to a Bloomberg terminal you can get for free on the internet with a paper trading account.
The mobile app is a lot simpler and offers graphical payout representations of options trades with up to four legs. There's also a web-based version if you're paranoid of installing apps.
https://www.tdameritrade.com/tools-and-platforms/thinkorswim.page (https://www.tdameritrade.com/tools-and-platforms/thinkorswim.page)
Optionalpha.com is a fun options learning site where the content creator does demos of thinkorswim to illustrate strategies.
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A 1010/1030 BCS puts $2,000 in capital at risk.
Time for me to learn - I think I have $810 at risk. I buy the $1010 call for $6,210 and then sell a $1030 call which pays me $5,400. If Tesla drops sharply, I keep $5,400 but lose $6,210 for a net loss of $810. In this case Tesla went up to $1080, and let's say that $1030 call is exercised by someone else. I think my broker would automatically charge my account ($1,080 x 100 = $108,000 minus $103,000) $5,000... but I could exercise my option ($1080 x 100 = $108,000 minus $101,000) and get a $7,000 credit. So I can lose $810 or I can profit $2,000, as I see it. (I'm sure in practice everyone would hold their options instead)
I'm not aware of an "automatically exercise [long], if [short] assigned" feature at any broker. I'd lay odds if you are decent programmer, you could get IB's "Trader Work Station" to automate that though. I use IB. IB will automatically start liquidating positions if you have a margin violation (they don't do margin calls). From experience, the algorithm, is coded to liquidate your positions in the least tax efficient manner possible. PROTIP: don't have a margin violation.
I have an IB account and programming experience. I don't know how much time investment is needed for me to learn trading both ETFs and options on IB's Trader Workstation. Any favorite tutorials, be they text or video?
But if you get your short leg assigned, by definition the long leg is still "in the money". So you are hedged and your margin requirement is [small]. Theoretically, you want to set up a combo order if assigned to buy back the short shares while selling the long call. This theoretically recovers some of the remaining time value and yields a bonus profit. Might actually even work on TSLA where liquidity is high. I've found when spreads get assigned early, I can't get the market maker to give up the time value that should rightfully be mine with a combo order. At any rate, early assignment usually means the TV remaining was already [low]. I've just made it a policy to log in and exercise my long call. There is no commission at IB that way so even if I could extract some time value the commissions would cut into it.
Sounds like I have a "time of exercise" risk, where assignment happens while I'm unable to exercise my call option. A volatile stock could then drop, leaving me with a profit that eats into my profit/premium. But you're saying that can be mitigated by closing both options early.
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KBecks - Thanks, appreciate the insight. Sounds like I don't need to take action at Vanguard.
ChpBstrd - I signed up for an HSA with HSA Bank, which places the investments at TD Ameritrade. So I have access to TD Ameritrade tools, but they wouldn't be useful for placing trades. Although... turning my HSA into play money and leaving everything else alone isn't the worst risk management idea...
Anyone else familiar with IB's Trader Workstation, I'd like to hear about time investment and how you learned to use it. I've seen one video talking about spreads, where at one strike you click the "bid" and another you click the "ask" to create a Combination Order.
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A 1010/1030 BCS puts $2,000 in capital at risk.
Time for me to learn - I think I have $810 at risk.
You are right. I had a brain fart. You cannot lose more than your net debit.
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I might experiment with this on small scale to learn, minimal loss.
anyone recommend best trading platform in UK? Or can options be done through a trading platform?
baz
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Suppose I have 500 shares of VT - current price 75.30, and I will want to sell them because I will need the money in a month or two.
Normally I would place a limit sell order at about 77 and wait. If it sells before I need the money, great. If not, I sell it at the market.
Would I more often be better off selling covered calls? And if so, how much better would it be?
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Here is an options chain for VT:
https://www.nasdaq.com/market-activity/funds-and-etfs/vt/option-chain
I put in an 8/21/20 expiration for funsies
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@bthewalls - Interactive Brokers has offices around the world, and a few people in this thread mentioned it for trading options. You can also trade ETFs for $0/trade, so it might provide international investors access to lower expense ratios, even without using options.
@oldladystache - Option contracts are 100 shares (almost always), so you need to have $7,500 worth of VT to create 1 covered call contract. If you had $22,500 that's 3 contracts (3 x 100 x $75/sh = $22,500). Most Vanguard clients haven't signed up for options trading, so you'd need to answer questions online about your rough financial situation (income, NW, investments) and experience (in ETFs, bonds, options).
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I don't think people are particularly interested in which options I'm buying, so instead I'm tracking that in the thread named "An experiment". I bought PUT options on DIN stock that expire July 17, because I predict restaurant profits are about to take a sharp hit from Covid-19 restrictions and scared customers.
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I don't think people are particularly interested in which options I'm buying, so instead I'm tracking that in the thread named "An experiment". I bought PUT options on DIN stock that expire July 17, because I predict restaurant profits are about to take a sharp hit from Covid-19 restrictions and scared customers.
While I don't disagree that restaurant profits will take a hit, do you think that will actually be reflected in the stock price in the next two weeks?
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I have been writing (sell to open) puts and covered calls lately on stocks that I already own and like. I think when I write a put *and* write a covered call, it's called a straddle. The stocks I'm doing this with are ones I know fairly well and don't mind owning shares of. I own several high revenue SAAS/tech stocks, ZM, CRWD, NET, WORK, FSLY, LVGO. I also write options (but don't get paid much) on DIS and SFIX. Some of these are rising in share price where writing options (I only do cash-covered puts) gets a little spendy, but I hold part of my port in cash.
Note that there is no way I would play with options on TSLA. Too spendy and I don't want to touch 100 share lots of TSLA.
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I don't think people are particularly interested in which options I'm buying, so instead I'm tracking that in the thread named "An experiment". I bought PUT options on DIN stock that expire July 17, because I predict restaurant profits are about to take a sharp hit from Covid-19 restrictions and scared customers.
While I don't disagree that restaurant profits will take a hit, do you think that will actually be reflected in the stock price in the next two weeks?
If states impose restrictions on restaurants (eating and mask wearing, pick one!), their revenue drops to zero and markets price that in. DIN has dropped -4% so far today while the overall market is up +1%. Another example is June, where DIN hit a peak value of $63/sh. It has dropped -38% from that peak (in under a month). If it drops -13% my put options break even. It's definitely risky, but overall I'm happy with the bet whichever way it turns out (payoff vs loss, chance of success given what I knew in advance).
KBecks - Are you aware of "TSLA7" mini options? The stock price is 1/10th of TSLA, and options are 10 shares per contract... so you wind up with prices 100x lower (1/10th from stock, 1/10th from smaller contracts).
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@bthewalls - Interactive Brokers has offices around the world, and a few people in this thread mentioned it for trading options. You can also trade ETFs for $0/trade, so it might provide international investors access to lower expense ratios, even without using option
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I don't think people are particularly interested in which options I'm buying, so instead I'm tracking that in the thread named "An experiment". I bought PUT options on DIN stock that expire July 17, because I predict restaurant profits are about to take a sharp hit from Covid-19 restrictions and scared customers.
Cool...I’ll look into it
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I'm not interested in TSLA. However, I was able to realize some premiums on this expiration Thursday. Set up a little bit for next week.
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I really appreciate everyone in this thread who have explained this topic so clearly and well. I have tried to understand options for a while now and this is the first time it has 'clicked.' Thank you all again, this community is awesome.
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I really appreciate everyone in this thread who have explained this topic so clearly and well. I have tried to understand options for a while now and this is the first time it has 'clicked.' Thank you all again, this community is awesome.
Just be careful. That "click" you heard might be the safety on a shotgun of doom going off. :-)
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I don't think people are particularly interested in which options I'm buying, so instead I'm tracking that in the thread named "An experiment". I bought PUT options on DIN stock that expire July 17, because I predict restaurant profits are about to take a sharp hit from Covid-19 restrictions and scared customers.
While I don't disagree that restaurant profits will take a hit, do you think that will actually be reflected in the stock price in the next two weeks?
I bought PUT options ($35 strike) on DIN stock, which dropped from about $43/share to $35.47/share now. Although it's not at my strike price yet, the options are much closer to profitable, so the market value has soared from $1.00/sh to $1.87/sh. I think that's my 2nd best option right now, with my two worst options either going nowhere or losing money. So these gains will probably need to cover for -100% losses in other options.
Something to consider: would I post this update if I was losing money on all options? Probably not. I would still post the start and end result, but this middle update is biased: it's posted because I'm doing well. Keep that in mind as you read about success stories - people are more likely to post them.
With only 5 trading days left, and markets realizing Covid-19 is serious (again), it doesn't make sense to imitate my trade now. You'd pay much higher costs for the options, with far fewer days left. It was a good bet to make when it wasn't expected, though.
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With only 5 trading days left, and markets realizing Covid-19 is serious (again), it doesn't make sense to imitate my trade now. You'd pay much higher costs for the options, with far fewer days left.
[/quote]
IDK, the volatility index has been falling for about a month now. The VIX can be read as a kind of shorthand for how expensive options are on the S&P 500. At 29, the VIX is historically high, but I'm not sure how high it is relative to a global pandemic that has infected millions, put tens of millions out of work, and may kill more Americans than World War 2 within its first 12 months. The case could be made that VIX will rise back into the mid-30s as the case for economic recovery withers under the faster spread of the virus. Schools are about to open!
https://finance.yahoo.com/quote/%5EVIX/ (https://finance.yahoo.com/quote/%5EVIX/)
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ChpBstrd - Earlier in this thread I was told "implied volatility" of the option is a better measure. Even for the same stock, some strike prices will have higher volatility than others. So you can't really assign the entire market a lower volatility - especially with the stocks I'm using, which are more volatile than the overall market.
I bought PUT options on a restaurant stock, a retail stock, and 3 others. Let's say the market price of the retail PUT option doubled, and someone imitated my trade and bought today. So they're paying twice as much for the same option. That means their break even point is twice as far from the strike price. And after that, their profits are half of mine. If I break even, they lose -50%. If I double my money, they break even, ... and so on. It's a very different bet owing to the much higher price.
If I wasn't worried about vaccine news in the next couple months, I might look at put options on volatile stocks that suffer during a shut down - especially those with weak financials. Maybe a travel-related stock (airline, hotel or cruise line).
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Some sobering words. I want the novices here to understand that even experienced options traders have trades that result in losses. I had a bull call spread in BAC with several percent downside protection that had 840 capital at risk. The Fed stress tests did a number on my holding and sent shares down past my downside protection. I held a little longer hoping for a rebound but shares just kept trading lower. I got out this morning with a $686 loss (33 days in force.) That is, a spread that started out with 60 cents a share was worth only 11 cents this morning.
I have two trades lined up for Monday. One where I have several percent downside protection in an out of the money short put that should yield around 25% annually and a bull call spread with 6% downside protection that has over 1,000% annualized profit potential. But! - I *could* take losses again. So...PRO TIP: be comfortable with quick large losses before you try to make quick medium sized gains with options.
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Question and comment....
I bought PUT options on DIN stock (listed on NYSE). When I click on details of the PUT options I hold, I see:
"Account Type: CASH"
Which I believe means this option is settled in cash, not in shares. Is that correct?
My comment is surprise. The current Covid-19 situation in the U.S. is about what I predicted, and I expected all of my options to be doubling or tripling. I'm not sure what to make of it, actually.... in total, those options have gained +40% since purchase (at the time of this post). This week I'll see if accurate Covid-19 predictions no longer become accurate investment predictions.
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Question and comment....
I bought PUT options on DIN stock (listed on NYSE). When I click on details of the PUT options I hold, I see:
"Account Type: CASH"
Which I believe means this option is settled in cash, not in shares. Is that correct?
My comment is surprise. The current Covid-19 situation in the U.S. is about what I predicted, and I expected all of my options to be doubling or tripling. I'm not sure what to make of it, actually.... in total, those options have gained +40% since purchase (at the time of this post). This week I'll see if accurate Covid-19 predictions no longer become accurate investment predictions.
The only options settled in cash are for indices. Perhaps what you’re seeing is a message that your account is not approved for margin? Or maybe it is that this position is cash-secured and not at risk of using margin if assigned.
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What I've heard is that you sell options into volatility. I'm not sure about the put buying strategy unless you are hedging your long portfolio.
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Question and comment....
I bought PUT options on DIN stock (listed on NYSE). When I click on details of the PUT options I hold, I see:
"Account Type: CASH"
Which I believe means this option is settled in cash, not in shares. Is that correct?
I suspect that since it says "Account Type" and not "holding type" it refers to your account wide trading permissions. That is, you do not have margin permissions. Is this a tax advantaged account?
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What I've heard is that you sell options into volatility. I'm not sure about the put buying strategy unless you are hedging your long portfolio.
My strategy is largely "sell options". I earn quite a lot more premium when vol is "high". But I also hedge with long puts on companies I feel are overly indebted, especially if they have declining sales. When TSHTF these tend to do very well often times coming in for a double or more. Just a few thousand here and there makes for a nice hedge. I also like to buy long dated puts on VXX. Contango in the futures markets tend to make that ticker decay over long periods of time. Has been my best, most repeatable trade since about 2010. I likely would not have been able to FIRE at 40 without that trade.
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What I've heard is that you sell options into volatility. I'm not sure about the put buying strategy unless you are hedging your long portfolio.
My strategy is largely "sell options". I earn quite a lot more premium when vol is "high". But I also hedge with long puts on companies I feel are overly indebted, especially if they have declining sales. When TSHTF these tend to do very well often times coming in for a double or more. Just a few thousand here and there makes for a nice hedge. I also like to buy long dated puts on VXX. Contango in the futures markets tend to make that ticker decay over long periods of time. Has been my best, most repeatable trade since about 2010. I likely would not have been able to FIRE at 40 without that trade.
There is about a 10-15% spread on August 12 VIX bull call spreads at the 22 and 23 strikes. I am trying to get an order through now if anyone would like to be my counterparty and bet that all this pandemic stuff gets back to normal next month. Anyone? 800% payoff if you’re right.
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Vanguard is a bit poor with communication on margin accounts, in my opinion. When my taxable account was approved, I didn't get a notification. I suddenly had "buying power" in my account, and had to call customer service to confirm that margin trading had been enabled. Last month I applied to make my Roth account enabled for margin loans, but didn't hear back, and it does not list "buying power".
ChpBstrd , Financial.Velociraptor - I think you're right that is means the account type. My bet against Covid-19 was in a non-margin Roth account.
My choices at this point, with 2 trading days left before the July 17th expiration:
(1) sell my PUT options. This captures some time value in exchange for giving up any profit/loss before the options expire. For thinly traded options, this might not be possible.
(2) exercise my profitable PUT options. I must own 100 shares to exercise one contract. So I would buy 100 shares, exercise one contract, and receive the profit from "PUT"ing those shares in someone else's account at the strike price. (I buy at $34, and sell at $35, for example).
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Last month I applied to make my Roth account enabled for margin loans, but didn't hear back, and it does not list "buying power".
Not allowed by law. You can only margin taxable accounts. The request for margin in Roth will either be ignored or denied.
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Vanguard hasn't communicated clearly, so denial/ignored amount to the same thing. But more importantly for this thread, I can now buy options in my Roth account.
I bought some long-term options on stock I am already holding. Options capture upside with less investment, but also require rolling out to later dates. Right now, I'm seeing some options have Jan 2021 and Jan 2022 with nothing in between. Is there a general rule on when new options are created?
For example, will Mar 2021 options be created later this year? Will Jan 2023 options be created in Jan 2021?
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The new LEAPS usually roll out in October and November. There is a schedule somewhere on the CBOE website that details how they are initiated. There are basically two cohorts. I believe a stock is assigned a cohort at random.
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That explains what I'm seeing. In Oct/Nov 2020, LEAPS for Jan 2023 will be created. LEAPS are always set for the third Friday in January. Options in March or June 2021 are not LEAPS - they are standard options.
I like to track stocks in a spreadsheet, but I'm having trouble making options fit the same format. I think there's several key fields... maybe stock price minus strike price, my cost to buy the option, current value of option, number of shares or contracts (100 shares/contract).
For those tracking options in a spreadsheet, what data are you tracking? Is there a small number of fields that capture all the key data?
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For options spreadsheeting:
I have calculations set up to determine my downside protection, my annualized return (to time normalize returns), capital at risk, and the normal info like entry date, expiry, strike, count of contracts, etc. I usually check the CBOE calculator to get my delta before pulling the trigger to make sure my statistical change of being in the money justifies the return. That is sometimes moot if I really want to own the underlying for the long term.
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Options are so different from stocks, I wound up having a separate area just for options.
And then I list their rough value when adding up total assets.
Last month I sold call options on a stock I own. I'm surprised that when someone did well and exercised the call options I sold, I was happy with it. I sold a lot of shares at $1.60. The person who bought my call option and exercised it forced me to hold shares until the stock passed $2.00, forcing me to have a +25% profit in a month. And that ignores the premium they paid me, for additional profit.
Essentially I wanted to sell some stock, and instead, I sold call options. The call options kept me invested for a profit, and paid me a premium for the contract, which was an additional profit. It's weird to be thinking about "win win" when it's the stock market, but that's my impression. (The stock could also have tanked, and caused a loss greater than the premium I was paid... a "lose lose").
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Options are so different from stocks, I wound up having a separate area just for options.
And then I list their rough value when adding up total assets.
Last month I sold call options on a stock I own. I'm surprised that when someone did well and exercised the call options I sold, I was happy with it. I sold a lot of shares at $1.60. The person who bought my call option and exercised it forced me to hold shares until the stock passed $2.00, forcing me to have a +25% profit in a month. And that ignores the premium they paid me, for additional profit.
Essentially I wanted to sell some stock, and instead, I sold call options. The call options kept me invested for a profit, and paid me a premium for the contract, which was an additional profit. It's weird to be thinking about "win win" when it's the stock market, but that's my impression. (The stock could also have tanked, and caused a loss greater than the premium I was paid... a "lose lose").
But imagine having sold a covered call on Microsoft or Tesla in April or May. It would be the worst 5-10% you ever earned :)
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I have been trading weekies and have a goal of trying to make $500 - $1,000 a week in income.
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But imagine having sold a covered call on Microsoft or Tesla in April or May. It would be the worst 5-10% you ever earned :)
Probably true. I'm in the reverse situation: the stock on which I sold covered calls was fastest, largest percentage gain I've ever had. That probably made me less sensitive to missing out on further gains. (The stock had already fulfilled my investment thesis for it - recovering, so I was ready to exit)
KBecks - At some point I plan to learn about "swing trading", which involves holding investments for days or weeks, like you describe.
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What I am doing is trading around a core position, so I might cover 1/3 or 1/2 of my shares, or write puts to add another 100. So I am a long term investor but working around the edges with the options for extra income.
Not all my trades work, next week might be a little rough but I'm trying to develop a - heads I win, tails I win - way of working with these.
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Back in March I picked dozens of deeply discounted individual stocks. They have a much higher risk of bankruptcy, but also a far greater potential reward than the average stock. I'm replacing some of my stock holdings with call options.
Let me use a fake number for an example. Like owning $2000 worth of Macy's stock ($6.45/sh), or 310 shares. Those could be replaced with Jan 2022 call options with an $8 strike price, which costs $190 per 100 share contract, or $570 to control 300 shares (strike $8). Assuming Macy's recovers to $23/share:
310 shares rise from $6.45/sh to $23/sh, so I invested $2,000 and made a $5,130 profit
3 contracts strike $8 worth ($23-$8)x300 - $570 = $3,930 profit.
Or buy 6 contracts: ($23-$8)x600 - $1140 = $7,860 profit
Investing less means less damage if the company declares bankruptcy. I can use some of the money that's freed up to pay "rolling forward" costs (buy a 2023 option and sell the 2022 option). And some money could go into other investments. The biggest danger is a Covid crisis that lasts for years, and drains the money I've set aside for rolling forward.
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The companies I am writing options on have share prices between $25 - $250.
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The conundrum with covered calls and short puts is that if the market rallies, you will miss out and have to buy back in at higher prices. If the market tanks, you have still suffered most of the damage.
You can say, “if assigned I’ll sell puts to get back in”, but by the time the stock has rallied, you will be unable to sell puts at your preferred strike price for more than a pittance. For example, I sold covered calls on a small “core” position in CRM, eventually getting called away at about $140. A series of puts sold for less than $1/share failed to get assigned over the past few months. Today the price is $190. Do I now sell puts near $190, and if assigned have I lost most of that $50/share gap? Or do I sell puts at $140, tying up large amounts of cash to earn pennies? If I choose not to play ball, do I buy a different stock or fund, thereby altering my AA? And should I not do that if that other stock or fund has gone way up too?
This may sound like a case for BnH rather than options, but my point is that when an option strategy involves a potential change of AA, the possibility of the market running away without you is a risk that cannot be ignored. It is standard to think of a covered call’s or short put’s risk profile as being the sum of all downside probabilities in cash-settled terms, but we should also factor in the risk of the stock we picked running away without us. If the stock runs away, we may never again have the purchasing power to pick up this many shares. E.g. If I was selling options on 100 shares of CRM, maybe now I can only afford 75. I have permanently lost 25 shares, all while taking almost the risk of owning 100!
This is particularly problematic for people like me who see the sum of EPS or free cash flow to be the foundations of my retirement. When you lose enough shares this way, eventually the sum of all the EPS/FCF for all your shares is less than it would have been via BnH.
You could say “When I win selling puts or calls (I.e. the price didn’t rise), I will reinvest those funds into shares of the stock”. However, stocks can rally faster (or fall faster) than you can earn premiums, as the CRM example demonstrates. So a bet on a long term option selling allocation is a bet that stocks will hold in a narrow range. If they fall too much you lose in cash terms and if they rally too much you lose share purchasing power as you enter the next play.
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The conundrum with covered calls and short puts is that if the market rallies, you will miss out and have to buy back in at higher prices. If the market tanks, you have still suffered most of the damage.
You are correct. There is no "free lunch". You have to give up something to "earn" that premium income. Your upside is what you trade away for current income. This is somewhat mitigated if you aren't married to a few particular tickers. If you can pivot to something else that is attractive at the time your other shares are called away, not much is lost.
I'm personally dealing with this situation. I sold covered calls on my NLY shares at 6.5 strike. They were above 6.5 just before ex-div so I rolled out, picking up enough TV that my counterparty did not call away my shares. I was hopeful that a pullback in the random walk would happen near the next expiry (this Friday) so I could roll "up and out" to 7. NLY finished the day at 7.27. Unless I want to put more capital into the trade (net debit), I will probably roll out to 6.5 again hope to hang on long enough for a pullback or to capture another distribution in a few months. Either way, I'm letting 10,000 dollars worth be called away this Friday. The market is telling me a got it wrong. I'm only 3/4 bullheaded and thus only going to partially try to go across the grain with deep(er) in the money covered calls.
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I've only sold covered calls on the micro-cap stock I wanted to exit. Shares will probably get called away at each option expiration date, since the stock has found a new trading range near my strike price.
More recently I've bought various Jan 2022 covered calls. In my stock picks, where I wait months or years for Covid-19 recovery, I'd like to replace stock by call options where it's possible. I found one odd case where the options prices are a bit nutty.
Casino "El Dorado Resorts" bought "Caesar's Entertainment" in a stock swap, after various regulators signed off on the deal. So the combined company (using CZR stock ticker) might be too dramatic a change for the options market, which has wide bid-ask spreads. The Jan 2022 options just don't make sense to me:
=== $29.74 stock (CZR), Jan 2022 call options:
$2.50 strike bid $25.20 ask $29.80 ImpVol 128%
$30.00 strike bid $10.50 ask $13.25 ImpVol 86%
$40.00 strike bid $8.05 ask $10.25 ImpVol 85%
There doesn't seem to be an efficient market for these options. Stock is like an infinite duration call option with a strike price of $0. So buying $29.74 of stock is much better than a $29.80 call option with a $2.50 strike price and expiration in 1.5 years. The fact that's the lowest ask price is bizarre to me (it's not stale - the last purchase was noon EST, and I checked the daily price movements).
Seeing so many asking prices +25% above the bid surprises me, as well. Maybe it's too soon after the merger, and the market isn't working efficiently yet. Maybe most investors are waiting for the next quarterly earnings report before they offer call options for sale.
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Two things here:
You noted low liquidity. By definition, that is a less efficient market. So you are probably seeing some true "wonkiness".
Deep in the money or deep out of the money options always look a little weird. It's a feature not a bug. A deep in the money call option has more "optionality" in that it is very likely to be money good. You'd expect higher time value in that case. Thing is the corresponding strike put has almost no chance of being money good and thus has very low time value. TV has be about the same for corresponding strikes on calls and puts, else "put-call arbitrage" scenario exists where traders can earn a riskless profit by playing both ends against the middle. There are big quant hedge funds that have powerful algorythms hunting for those arbs with great efficiency. Thus, deep in the money options have behavior that appears a little counter-intuitive.
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This is probably something to do with the merger details. Will ticker symbol CZR exist a couple of months from now, or will all those long-duration options be closed out or converted to non-standard after completion of the merger? Rest assured that the market makers have figured out the correct price.
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ChpBstrd - El Dorado Stock (ERI) has been delisted. The Caesar's brand and stock (CZR) will continue, although maybe the company will technically be named El Dorado. How do you view the wide bid-ask spreads? From my experience with ETFs, it looks like a failure to make an orderly market... but I'm not as familiar with options markets, so another perspective would be interesting.
Financial.Velociraptor - Low volume also means stale trades, so I sorted by most recent trade, and here's the most recent trades for Jan 2022 call options:
call $40 strike (today $8.95) bid $8.50 ask $9.20 ImpVol 80%
call $50 strike (today $6.80) bid $4.85 ask $8.00 ImpVol 76%
Still odd to see an ask price +65% higher than the bid price. At least the $40 strike looks orderly.
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I've settled into a pattern with buying long-dated call options. I'll typically wait for a day when a stock is falling, and then buy just out of the money call options. It could also be that Covid-19 is fueling pessimism in both stock and options markets, and people want to exit their positions and buy at a lower point.
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Hi all, I’m still a noob on options so this may be a ridiculous question. Ok I was looking at an Iron Condor for Capital One (COF) for 9/18, buying the 57.5 Put, selling the 62.5 Put, selling the 65 Call, and buying the 70 Call. The net is a credit of about $350 at current options prices, and the max loss is $150. So I got the $350 credit in cash, and now the max loss I could incur on expiration is $150 according to think or swim. So have I just earned $200 if I hold to expiry or am I missing something?
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Hi all, I’m still a noob on options so this may be a ridiculous question. Ok I was looking at an Iron Condor for Capital One (COF) for 9/18, buying the 57.5 Put, selling the 62.5 Put, selling the 65 Call, and buying the 70 Call. The net is a credit of about $350 at current options prices, and the max loss is $150. So I got the $350 credit in cash, and now the max loss I could incur on expiration is $150 according to think or swim. So have I just earned $200 if I hold to expiry or am I missing something?
@ouroboros
Your ideal scenario is the underlying finishes on 18SEP2020 between 62.5 and 65. You thus keep $350 in cash with no further obligation. Should the price fall below 60 or rise above 65, you start incurring obligation. You will have bought shares at 62.5 or sold at 65, respectively. With the underlying above or below (respectively) those data points, you would have to incur a short term capital loss to close the shares. That loss grows the further below 60 or above 65 the price goes. The worst you can do is if the price falls to 57.5 or lower; OR; at 65 or higher. That is your losses are hedged at 57.5 and 70. You can thus lose 500 dollars at most (5 dollar distance between the strikes times 100 shares) on either wing of the condor but not both. Your 500 in losses less your 350 credit received in cash is a net capital loss of $150. Prices between the two puts or between the two calls have different results depending on how deep in the money the short (sold) put/call are. For example a price of 60 or 67.5 puts your 2.5 dollars in the money (times 100 shares). You would take 250 dollars in capital loss against 350 in capital gain for a net gain of 100 dollars. Any outcome between minus 150 and positive 350 is possible.
This is a hard way to make money in this market. Times are very volatile and you made a play that depends on volatility being low.
[edit - Used 60 above when I meant 62.5, corrected]
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Thank you so much for the detailed explanation, that makes sense and I knew it couldn’t be that easy.
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How do you view the wide bid-ask spreads? From my experience with ETFs, it looks like a failure to make an orderly market...
Still odd to see an ask price +65% higher than the bid price. At least the $40 strike looks orderly.
Wide bid-ask spreads are common among companies and funds with thin liquidity in their options markets. Instead of a bustling marketplace of competitive traders, imagine a single gas station on a dusty highway next to a sign that says "next gas 100 miles". You might place a limit order for the midpoint between the bid and ask, but it would probably be wiser to have a program calculate the expected value of the option and to offer that. Market makers will place a "stink bid" on options just to catch the occasional fish, and that can move the midpoint off the actual value of the option. Oftentimes if you place a fair offer on the market, your trade won't get executed because no one is interested in a fair offer. They only trade for profits.
Even worse, when it is time to exit, roll, or adjust your position, you run into the same problem.
My preferred approach is to not play in these kinds of markets. I pay a little extra for the expense ratio of SPY instead of VOO because the much more liquid options market will save me many more dollars than the ER when I am using a long-duration collar strategy.
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Hi all, I’m still a noob on options so this may be a ridiculous question. Ok I was looking at an Iron Condor for Capital One (COF) for 9/18, buying the 57.5 Put, selling the 62.5 Put, selling the 65 Call, and buying the 70 Call. The net is a credit of about $350 at current options prices, and the max loss is $150. So I got the $350 credit in cash, and now the max loss I could incur on expiration is $150 according to think or swim. So have I just earned $200 if I hold to expiry or am I missing something?
With enough volatility, could you lose money in both directions? Against both the PUT and CALL?
Let's say the Fed provides negative news on interest rates, which impacts Capital One (COF). Let's COF drops to $56.50, and the put you wrote gets exercised. Your losses stop at $56.50 (the protective put you bought), so you've lost $500.
But now COF announces quarterly results, and they've done really well, and the Fed news doesn't seem relevant to them. So COF recovers from the Fed situation, and then goes on to make gains... let's say they hit $70/share. The call you sold would get exercised, costing you $500.
By that scenario, of a sharp drop followed by a very quick increase, I see $1,000 in losses are possible.
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How do you view the wide bid-ask spreads? From my experience with ETFs, it looks like a failure to make an orderly market...
Still odd to see an ask price +65% higher than the bid price. At least the $40 strike looks orderly.
Wide bid-ask spreads are common among companies and funds with thin liquidity in their options markets. Instead of a bustling marketplace of competitive traders, imagine a single gas station on a dusty highway next to a sign that says "next gas 100 miles". You might place a limit order for the midpoint between the bid and ask, but it would probably be wiser to have a program calculate the expected value of the option and to offer that. Market makers will place a "stink bid" on options just to catch the occasional fish, and that can move the midpoint off the actual value of the option. Oftentimes if you place a fair offer on the market, your trade won't get executed because no one is interested in a fair offer. They only trade for profits.
Even worse, when it is time to exit, roll, or adjust your position, you run into the same problem.
My preferred approach is to not play in these kinds of markets. I pay a little extra for the expense ratio of SPY instead of VOO because the much more liquid options market will save me many more dollars than the ER when I am using a long-duration collar strategy.
Good point about low volatility and rolling my position. In your metaphor, I pay more at the remote gas station... and then on the drive back, I have to stop for gas again. They make money both times, at much higher rates. I think I'll avoid call options on CZR stock.
For now, I plan to only buy call options for "Covid recovery" type stocks, like Macy's (retail), DIN (restaurant) or Caesar's / El Dorado (casino). Here I'm just replacing the stock with call options, to reduce my losses in a bankruptcy and maybe provide some leverage. After Covid, all should recover... which I hope occurs sooner, but I'm keeping cash to roll out to a date 2.5 years from now.
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With enough volatility, could you lose money in both directions? Against both the PUT and CALL?
Let's say the Fed provides negative news on interest rates, which impacts Capital One (COF). Let's COF drops to $56.50, and the put you wrote gets exercised. Your losses stop at $56.50 (the protective put you bought), so you've lost $500.
But now COF announces quarterly results, and they've done really well, and the Fed news doesn't seem relevant to them. So COF recovers from the Fed situation, and then goes on to make gains... let's say they hit $70/share. The call you sold would get exercised, costing you $500.
By that scenario, of a sharp drop followed by a very quick increase, I see $1,000 in losses are possible.
This is true if and only if you close out your hedge before expiry. If you keep the long put and long shares, and the price reverses, you bought at what turns out to be a great price. If you exercise your hedge put upon assignment and then prices reverse past your call hedge, you lost 1000.
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I've been playing with options for years, and there is a certain casino aspect to them that is hard for me to shake. It is necessary to pick a direction stocks will go: up, down, or neutral. It is also necessary to pick a timeframe. The roulette table is a good metaphor: you can bet on black or red or you could do a long shot bet on a particular number or the "black swan" green, but any way you bet the house makes their profits on a margin, and all the rules and processes and glitter are there to obscure that margin. Just as there are no casinos without edges, there are also no free lunches in option world. The presence of books and internet gurus breathlessly promoting surefire riches if you can just let them teach you the rules of the game is yet another signal.
When you go to the horse track, you can generally tell which horse is going to win based on the odds. Even something as random as one horse running a tenth of a second faster than another horse is somehow sussed out by an efficient market of betters, yet the only people making consistent money are the track owners.
Yet, we FIRE investors face a conundrum that can only be solved by options. Options are the only practical way to truly hedge a long stock investment. Sure, you can diversify and still accept all systemic risk or you can dabble in futures and risk unlimited losses, but when you buy a put you know exactly where the floor is.
The market for long assets is almost completely decoupled from the depression-like economic reality facing workers and businesses, and it is known that assets are being inflated primarily by money printing and government purchases. And if anyone thinks 10 year treasuries yielding half a percent provides safety or diversification, I wonder where they think their retirement income will come from. At least cash under the mattress has no interest rate risk. So much of the traditional wisdom such as "stocks grow with the economy" and "bonds offer diversification and safer income" do not apply in our current post-capitalist era, where QE has replaced the economy and speculative investments have replaced bonds and the government is printing money to take increasing shares of ownership in formerly private industry. We investors have certainly lost something in this transition - the ability to diversify our income streams, the ability to measure and control risk, and the ability to predict the factors that in bygone years would determine stock performance. Now we can only guess at a narrative of what the Fed will do; will they inflate or deflate the bubble?
This is where limited-loss-potential equity investments shine.
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There doesn't seem to be an efficient market for these options. Stock is like an infinite duration call option with a strike price of $0.
That's an ingenious way to think of that! That never occurred to me, but I'm sure my brain danced around the idea. Can I ask if that is a MustacheAndaHalf original or did you read it somewhere?
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Some sobering words. I want the novices here to understand that even experienced options traders have trades that result in losses.
^Totally agree. I've been doing this like a decade now and the best laid plans can still end up being a dumpster fire. The big lesson I learned was don't put all your eggs in one basket (have multiple bets going), never make an unlimited loss trade, be long volatility, and try to trade in a way where your wins can outweigh any losses.
I trade a lot of biotech (I'm an oncology pharmacist IRL), and that's a great arena to knock you down a few pegs if you start to feel to smart. Even with the best data drugs fail clinical trials or equity offerings eat up your gains, competitors leapfrog you, etc, etc.
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What I've heard is that you sell options into volatility. I'm not sure about the put buying strategy unless you are hedging your long portfolio.
My strategy is largely "sell options". I earn quite a lot more premium when vol is "high". But I also hedge with long puts on companies I feel are overly indebted, especially if they have declining sales. When TSHTF these tend to do very well often times coming in for a double or more. Just a few thousand here and there makes for a nice hedge. I also like to buy long dated puts on VXX. Contango in the futures markets tend to make that ticker decay over long periods of time. Has been my best, most repeatable trade since about 2010. I likely would not have been able to FIRE at 40 without that trade.
I remember you used to use UVXY until leveraged was reduced. I still think this is one of the smartest trades I've ever seen, missed by the crowds, noticed by the velociraptor
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Last month I applied to make my Roth account enabled for margin loans, but didn't hear back, and it does not list "buying power".
Not allowed by law. You can only margin taxable accounts. The request for margin in Roth will either be ignored or denied.
You can get "Limited Margin" through some brokers on IRAs. My TD Ameritrade traditional IRA has limited margin and allows me to trade any limited-risk spread. I mostly trade diagonals in that account.
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Hi all, I’m still a noob on options so this may be a ridiculous question. Ok I was looking at an Iron Condor for Capital One (COF) for 9/18, buying the 57.5 Put, selling the 62.5 Put, selling the 65 Call, and buying the 70 Call. The net is a credit of about $350 at current options prices, and the max loss is $150. So I got the $350 credit in cash, and now the max loss I could incur on expiration is $150 according to think or swim. So have I just earned $200 if I hold to expiry or am I missing something?
If you want a detailed explanation of why iron condors sound great in theory but are much harder to trade in reality, this article has an in depth explanation of a brokerage that went bust trying to sell them for their clients: https://earlyretirementnow.com/2019/09/11/ubs-another-option-strategy-failure/ (https://earlyretirementnow.com/2019/09/11/ubs-another-option-strategy-failure/)
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And if anyone thinks 10 year treasuries yielding half a percent provides safety or diversification, I wonder where they think their retirement income will come from.
I feel the same way. No matter what's going on with the actual underlying equity price, I still feel like I can make a reasonable % selling covered calls or buying lotto tickets (long calls/puts).
I strongly agree with everything else you said but clipped the quote for efficiency's sake.
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There doesn't seem to be an efficient market for these options. Stock is like an infinite duration call option with a strike price of $0.
That's an ingenious way to think of that! That never occurred to me, but I'm sure my brain danced around the idea. Can I ask if that is a MustacheAndaHalf original or did you read it somewhere?
I thought it up as a solution to a couple problems in spreadsheets I was creating. I wanted to add options to a list of stocks, and thought about converting all the stocks to look like options (of unlimited length). I also tried comparing expected profit of various options, and wanted to check and see that options acted similarly (or better) to stock. So I thought it up, but I'm doubtful I'm the first to do so.
Last month I applied to make my Roth account enabled for margin loans, but didn't hear back, and it does not list "buying power".
Not allowed by law. You can only margin taxable accounts. The request for margin in Roth will either be ignored or denied.
You can get "Limited Margin" through some brokers on IRAs. My TD Ameritrade traditional IRA has limited margin and allows me to trade any limited-risk spread. I mostly trade diagonals in that account.
When I searched, I saw Fidelity and IBKR listed in the results, but not Vanguard. Under a page showing how to avoid a "freeriding violation" (sell then buy before settlement), Vanguard suggests margin - but only for "nonretirement" accounts.
https://investor.vanguard.com/investing/online-trading/trading-penalties
"Consider margin investing for nonretirement accounts"
Since I favor the other benefits of my Vanguard IRA, I'm keeping it at Vanguard. I can trade options there at a higher price ($1/contract, more than IBKR), but stocks at a lower price ($0/trade versus IBKR charging for stock trades).
Hm, but it might be interesting to have IRAs in both places... options at IBKR and stocks at Vanguard.
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What I've heard is that you sell options into volatility. I'm not sure about the put buying strategy unless you are hedging your long portfolio.
My strategy is largely "sell options". I earn quite a lot more premium when vol is "high". But I also hedge with long puts on companies I feel are overly indebted, especially if they have declining sales. When TSHTF these tend to do very well often times coming in for a double or more. Just a few thousand here and there makes for a nice hedge. I also like to buy long dated puts on VXX. Contango in the futures markets tend to make that ticker decay over long periods of time. Has been my best, most repeatable trade since about 2010. I likely would not have been able to FIRE at 40 without that trade.
I remember you used to use UVXY until leveraged was reduced. I still think this is one of the smartest trades I've ever seen, missed by the crowds, noticed by the velociraptor
I think this is the trade people talk about when they say never to be "short volatility". @Financial.Velociraptor may have managed to work this one well, but I got my clock cleaned.
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What I've heard is that you sell options into volatility. I'm not sure about the put buying strategy unless you are hedging your long portfolio.
My strategy is largely "sell options". I earn quite a lot more premium when vol is "high". But I also hedge with long puts on companies I feel are overly indebted, especially if they have declining sales. When TSHTF these tend to do very well often times coming in for a double or more. Just a few thousand here and there makes for a nice hedge. I also like to buy long dated puts on VXX. Contango in the futures markets tend to make that ticker decay over long periods of time. Has been my best, most repeatable trade since about 2010. I likely would not have been able to FIRE at 40 without that trade.
I remember you used to use UVXY until leveraged was reduced. I still think this is one of the smartest trades I've ever seen, missed by the crowds, noticed by the velociraptor
I think this is the trade people talk about when they say never to be "short volatility". @Financial.Velociraptor may have managed to work this one well, but I got my clock cleaned.
@talltexan Position sizing is the key to betting against VXX or UVXY. (If you are academically oriented, look up the black-jack/poker calculation for "risk of ruin"). There is always a non-zero chance the thing can go up hundreds of percent in a few days. It is a sure bet over "long" periods of time it will decline. But if you are 100% allocated when it blows past you, you risk being completely wiped out. Keeping position size down to 5-10% allows you to sit on the underwater position for more than a year while you wait for it to recover via contango decay.
For example, I have been playing VXX for years. In January I bought the 13 strike with Jan 2022 expiry for 5.25 a share. Coronavirus put that deeply underwater. I'm currently sitting on a 44% unrealized loss. I expect it to eventually break even as normalcy for that ticker is a 60% annual decline (although it hurts to have 5% of my portfolio 'dead money' for more than a year). I have a second 5% allocation on the 32 strike entered early June. That is up nicely and I hope to roll it down next week if the market continues to cooperate.
My early retirement was at least 50% driven by gains against UVXY. I got burned pretty good when they lowered the leverage, which killed my TV. Thus, I now stick to the unleveraged VXX.
But indexing is fine. Most of the people who ask me for investing advice I tell to index after reviewing their goals and risk tolerance.
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Indeed I might have given up too early on that trade. If I went back to it, I would try to have contracts staggered to different times so I wouldn't every get fully wiped out.
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I had a very good week with weeklies. Initially thought I might have done too many trades, but they worked out well, all positive except one small one I was experimenting with.
Now... have to work on next week.
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@Financial.Velociraptor (and others) - I currently have many call options that expire in 1.5 years, in Jan 2022. Since some scenarios might involve a recovery that takes even longer, I'm preparing to roll out these options. Just to revisit what you said earlier:
The new LEAPS usually roll out in October and November. There is a schedule somewhere on the CBOE website that details how they are initiated. There are basically two cohorts. I believe a stock is assigned a cohort at random.
In 2-3 months, I should get a chance to roll forward my call options. As call options get more distant in the future, their time value costs less per month. My guesstimate is 3% per month, so selling 1.2 year dated options (Jan 2022) and buying 2.2 year dated options (Jan 2023) might cost an extra +36% to roll forward.
When new LEAPS are first issued, is that a good time to buy them?
I assume those days will be higher volume, which means more efficient pricing of options.
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When new LEAPS are first issued, is that a good time to buy them?
I assume those days will be higher volume, which means more efficient pricing of options.
I find the first week after issuance the liquidity is even lower than normal for a long dated LEAP. Wide bid/ask spreads abound which require limit orders and lots of patience to get a fair fill.
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What I've heard is that you sell options into volatility. I'm not sure about the put buying strategy unless you are hedging your long portfolio.
My strategy is largely "sell options". I earn quite a lot more premium when vol is "high". But I also hedge with long puts on companies I feel are overly indebted, especially if they have declining sales. When TSHTF these tend to do very well often times coming in for a double or more. Just a few thousand here and there makes for a nice hedge. I also like to buy long dated puts on VXX. Contango in the futures markets tend to make that ticker decay over long periods of time. Has been my best, most repeatable trade since about 2010. I likely would not have been able to FIRE at 40 without that trade.
I remember you used to use UVXY until leveraged was reduced. I still think this is one of the smartest trades I've ever seen, missed by the crowds, noticed by the velociraptor
I think this is the trade people talk about when they say never to be "short volatility". @Financial.Velociraptor may have managed to work this one well, but I got my clock cleaned.
If it makes you feel any better (misery loves company, they say) I jumped in on this trade just in time for the fund to be deleverages, but thankfully I got lucky and didn't have a very large position.
Full disclosure I am currently long VXX for some OTM calls, hoping that between the virus and the election we get some more choppy waters by the end of the year. But same situation, those long options are less than 1% my total trading account.
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Indeed I might have given up too early on that trade. If I went back to it, I would try to have contracts staggered to different times so I wouldn't every get fully wiped out.
I'm wrong more than I'm right so I always, always advocate "laddering" your options trades across different strikes and time frames.
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wrote two puts this week and hopefully will make my weekly income target.
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wrote two puts this week and hopefully will make my weekly income target.
@KBecks
What did you write puts on and what strike did you select? On Monday, I wrote two ITB puts at 51.5 strike (with underlying at 52.22 for some downside protection) - 42.25% annualized return if unassigned.
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Looks like I'll be avoiding new LEAPS call options the week they come out. Too bad, since it's probably going to be a very volatile time (2020 election news, vaccine trial results).
I picked stocks like Macy's that do badly under lock downs. So those options are dropping in value, which I expected when Covid-19 threatens new lock downs (or even just reduced shopping). I've got options that last 1.5 years, during which I hope a recovery occurs. Since hope isn't a strategy, I've set aside cash to "roll forward" those options to 2.5 years. If Covid lasts 3.5 years or more, my call options probably become more expensive than just holding stocks... we'll see.
Earlier I tried to use put options to time the second wave of Covid-19 in the U.S., but people's thinking and reactions have changed. It was a small investment that failed. But it helped me realize I can't predict the up and down as clearly now as in March/April, and to simply stick to waiting for a recovery. So for me, I'm limited to long-dated call options until the end of Covid-19.
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wrote two puts this week and hopefully will make my weekly income target.
@KBecks
What did you write puts on and what strike did you select? On Monday, I wrote two ITB puts at 51.5 strike (with underlying at 52.22 for some downside protection) - 42.25% annualized return if unassigned.
I wrote a $132 strike put on Livongo, LVGO and a $105 strike put on Fastly, FSLY. Earnings come out today and tomorrow so shares could be volatile.
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Seeing how much options can fluctuate, I've dropped the idea of keeping cash to roll forward options. One example is my Macy's call options, which went up +18%. That means the cost of rolling forward went up a similar amount, leaving my cash reserve behind. So I don't think setting aside cash to roll forward makes sense.
Since stocks and cash are less volatile than options, maybe the answer is "more options". Take that cash, and buy more options, which then rise or fall in value. When it comes time to roll forward, some of the investment in options can be sold to roll forward the rest.
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Seeing how much options can fluctuate, I've dropped the idea of keeping cash to roll forward options. One example is my Macy's call options, which went up +18%. That means the cost of rolling forward went up a similar amount, leaving my cash reserve behind. So I don't think setting aside cash to roll forward makes sense.
Since stocks and cash are less volatile than options, maybe the answer is "more options". Take that cash, and buy more options, which then rise or fall in value. When it comes time to roll forward, some of the investment in options can be sold to roll forward the rest.
You may be anchoring on the stock price. Yes, if the stock goes up it will cost more to roll the options at the same old $X strike, but if volatility, duration, and a few other factors are similar you will still be able to buy a similar option X% out of the money in the future. With options strategies, one is less tied to the “buy low sell high“ objectives of conventional stock investing. It is more of a time-bound probability game than a game of getting a good price on the stock, and the options pricing equations are agnostic about what constitutes a good deal on a stock.
That said, strategy gets complicated when one says “I want to own XYZ at $100/share, so I will write a put at the $100 strike and roll until assigned.” What happens next is the stock may run away and never return to $100. Meanwhile the premiums one can earn rolling $100 puts dwindle to nearly nothing. The way to get oneself in that bind is to try to play both games (buying stock and selling options) at once - the conflicting dominant strategies can leave one with few routes to success: If the stock rises, you should’ve bought the stock and if it falls you also lose.
For long call strategies, volatility contributes less to the call’s price when vol is low, and it is low when stocks are rising. So some of the call’s time value evaporates even as the price of the stock goes up. The overall appreciation of the call is thus inhibited. So if you buy a call for a good price, it is probably because stocks have been rising and vol is low, and if you want to leverage your upside during a correction, you’ll pay dearly because vol is so high.
So if you have your eye on an attractive stock, take it from someone who’s made the mistake before and just buy it. Similarly, if you think a stock is shite, buy a put during low vol times and wait for a correction when both vol and delta will appreciate your put simultaneously. Or take a neutral strategy and buy protection when vol is low.
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It's not anchoring if my cash can't cover a cost. It's just not enough cash.
I'm predicting "stocks recover", but let me give specific examples with Macy's stock. I start with 100 shares of M, costing $700. If I hold Macy's until recovery, I hope it reaches somewhere near $16.60. ($16.60 / $7 = 2.37, or +137% in a recovery)
Or I can hold a mix of options and cash, with the cash set aside to roll forward. I could buy "M Jan 2022 10.000 call" contracts at $1.50/contract (x 100 shares). So I can spend $300 to buy those 2 contracts, and in a full recovery make more than holding stock. ($16.60 - $10 / $1.50 = 4.4, or +340% in a recovery) ... (or, including the roll forward cash: $16.60 - $10 / $2.25 = +193%)
My estimate is 3%/month to roll forward 1.1 year options to 2.1 year options. If I conservatively estimate 4%/month and round up to 1/2, I would set aside $150 to roll forward $300 worth of options. So I have $300 worth of call options, $150 cash, and can use $250 to invest elsewhere.
Back on July 15th, Macy's soared +10% in one day (from Moderna's vaccine candidate entering stage III testing, if I recall correctly). It's current price is about +20% above it's low for the past 30 days. Per my thesis that "stocks recover", I believe a drug completing a stage III vaccine trial would cause Macy's stock to spike up significantly, maybe +30% or +50%. And it's likely that happens before I get the chance to roll forward, which means option prices for Macy's will be significantly higher - and the option could be in the money, making it even more expensive to roll forward.
Now back to my pricing. My $10 strike on a stock trading at $7 is +43% above the current price. If Macy's stock goes up +50% to $10.50, I can't just add +43% to the new price: a $15 option is very close to Macy's recovery point ($16.60 - $15.00 = $1.60), while a $10 option has much more room ($16.60 - $10 = $6.60). A fixed percentage doesn't work for my thesis that stocks recover, because I'm predicting a specific stock price rather than a percentage gain.
EDIT: Added profit calculation with "roll forward" cash included.
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I've been using Covered calls extensively for a couple of years now with pretty decent success. I have written several long detailed comments on my mechanics on Seeking Alpha articles on related topic. Basically a 30 delta call 30 days out with at least 1 - 1.5% premium on index etfs. I purposefully converted my retirement investments from Vanguard funds to $SPY and $QQQ. In a rabid bull market like we are in now or were prior to Coronavirus, I have to roll up and out a Lot as I dont want to lose the shares. If rolling is for a credit, its still okay (even though you are not making much new money), but rolling for a large debit is a killer...Some of these details can only be learnt by actually doing it and not by reading or watching videos. So, if anyone wanting to start, I suggest start with 100 shares of $QQQ and write a 30 delta call 30 - 45 days out. Once you have done this for 3 - 6 months and importantly familiar with Rolling, start also selling a 16 delta put in addition to covered call (so called covered strangle).
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First, a big thanks to @Financial.Velociraptor , not just for the sharing he provides here but the sharing he provides in his blog. He has personally helped me become a better educated investor.
Second, I'd be in favor of a "Advanced Options Heretics Thread" if you ever have the desire to create it. There are a ton of other topics that it's always great to learn about.
Personally, I started my options journey probably 10 years ago when I learned you could use call options to create leveraged stock holdings. Sounded great. I had no idea what I was doing, but bought a few deep OTM call options on some stocks I thought were going to increase. Fast forward a few months, and the underlying would increase but my option would decrease. I left at the time thinking "options are hard and difficult to understand" when in reality I didn't have a full grasp on how options were valued. I knew the greeks existed, but I didn't know how they really worked. Now with a firm grasp of delta, time decay, and volatility as it relates to options pricing, options don't see so complicated.
I moved on to covered call writing, stuck with it heavy for a year or two, which helped me fully understand the change of delta and IV when figuring out my options. I now sell more naked puts than covered calls.
Speaking of, for your "advanced" series, I'd personally like to see more discussion on a few topics, namely:
1. Covered Calls vs. Short Puts (see https://www.youtube.com/watch?v=m7vT8iJJbLQ)
Most think covered calls are "smart" and "safe" while short puts are "dumb" and "risky", when in practice it isn't quite that simple. It requires a better understanding of the use of margin vs. cash secured positions though.
2. Short Put writing as an income stream
You hear so much talk about how writing naked puts are dangerous. But if you look at some of the studies (https://spintwig.com/spy-short-put-0-dte-leveraged-options-backtest/ where the use of a 0 DTE 16 or 30 Delta put on SPY can produce a consistent income stream, with relatively low risk) you can see there are a ton of possibilities. I paper traded a 0 DTE 30 Delta XSP strategy for two months, and it proved very successful. I moved real money into the strategy about 6 weeks ago, and it's produced about $30 per day on average, with ~$6,000 at "risk." Not every day is green of course.
3. Using VXX
Namely, I'd love to hear more about what you're doing:
I also like to buy long dated puts on VXX. Contango in the futures markets tend to make that ticker decay over long periods of time. Has been my best, most repeatable trade since about 2010. I likely would not have been able to FIRE at 40 without that trade.
What time period are you targeting, what metrics (Delta, are you watching volatility leading up to and entering the trade, when do you roll, etc.) do you use?
I was just analyzing some of these strategies a while back when the VIX exploded. I figured it was too risky for me (or possibly no longer a viable trade), but have been watching money be printed since then.
Thanks again for all you do @Financial.Velociraptor !!!!!
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First, a big thanks to @Financial.Velociraptor , not just for the sharing he provides here but the sharing he provides in his blog. He has personally helped me become a better educated investor.
Second, I'd be in favor of a "Advanced Options Heretics Thread" if you ever have the desire to create it. There are a ton of other topics that it's always great to learn about.
Personally, I started my options journey probably 10 years ago when I learned you could use call options to create leveraged stock holdings. Sounded great. I had no idea what I was doing, but bought a few deep OTM call options on some stocks I thought were going to increase. Fast forward a few months, and the underlying would increase but my option would decrease. I left at the time thinking "options are hard and difficult to understand" when in reality I didn't have a full grasp on how options were valued. I knew the greeks existed, but I didn't know how they really worked. Now with a firm grasp of delta, time decay, and volatility as it relates to options pricing, options don't see so complicated.
I moved on to covered call writing, stuck with it heavy for a year or two, which helped me fully understand the change of delta and IV when figuring out my options. I now sell more naked puts than covered calls.
Speaking of, for your "advanced" series, I'd personally like to see more discussion on a few topics, namely:
1. Covered Calls vs. Short Puts (see https://www.youtube.com/watch?v=m7vT8iJJbLQ)
Most think covered calls are "smart" and "safe" while short puts are "dumb" and "risky", when in practice it isn't quite that simple. It requires a better understanding of the use of margin vs. cash secured positions though.
2. Short Put writing as an income stream
You hear so much talk about how writing naked puts are dangerous. But if you look at some of the studies (https://spintwig.com/spy-short-put-0-dte-leveraged-options-backtest/ where the use of a 0 DTE 16 or 30 Delta put on SPY can produce a consistent income stream, with relatively low risk) you can see there are a ton of possibilities. I paper traded a 0 DTE 30 Delta XSP strategy for two months, and it proved very successful. I moved real money into the strategy about 6 weeks ago, and it's produced about $30 per day on average, with ~$6,000 at "risk." Not every day is green of course.
3. Using VXX
Namely, I'd love to hear more about what you're doing:
I also like to buy long dated puts on VXX. Contango in the futures markets tend to make that ticker decay over long periods of time. Has been my best, most repeatable trade since about 2010. I likely would not have been able to FIRE at 40 without that trade.
What time period are you targeting, what metrics (Delta, are you watching volatility leading up to and entering the trade, when do you roll, etc.) do you use?
I was just analyzing some of these strategies a while back when the VIX exploded. I figured it was too risky for me (or possibly no longer a viable trade), but have been watching money be printed since then.
Thanks again for all you do @Financial.Velociraptor !!!!!
@specialkayme
Thanks for the kind words!
Let's see if others want an advanced thread or to just fill out this thread with more discussion. I don't want to become a burden on the moderators or attract Boglehead trolls.
I'm not what precisely sure you are asking about the difference between covered calls and short puts. Maybe your are referring to "naked" e.g. "uncovered" puts. Cash secured puts have the same theoretical profit/loss profit as the same strike covered call. This makes a lot of sense as if there was a wide difference, you could arbitrage it away for a riskless profit. (Of academic note, there is actually a very small (few pennies) persistent out of balance where puts are ever so slightly more valuable than calls. It is called the "negative skew.")
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financial.velociraptor, I rarely post but have been following this thread, as well as the "fun with VIX options" thread from a couple years back. I remember that ran into problems when the ETF de-leveraged, and then I think there was additional trouble in the market wobbles of late 2018. I remember reading intently about the decay in the underlying over long time spans (1-2 years) and the availability of LEAPS, but I don't fully understand or remember what the trouble was at the end. I for one would be interested in hearing more about that, especially since you reference it again on this thread, and it sounds like you are still doing some version of it.
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I'm not what precisely sure you are asking about the difference between covered calls and short puts.
I just think it's a topic area that should be discussed more, and something I wish was explained to me earlier on.
Covered Calls are often the "gateway drug" to the options world. Usually at this stage, investors believe Covered Calls are low risk with great reward. But you can accomplish the same thing by selling a put at the same strike price. Same profit potential, same loss potential. Only you can choose to have short puts cash secured (fully or partially) vs the use of margin.
Look at TGT as an example, a good aristocrat dividend stock. Trading this am (premarket) at $137.75.
1. Covered call option
I can buy 100 shares of TGT stock ($13,775) and sell one 9/18 option with a 145 strike for $230.
Cost: $13,545 (stock price less the option received)
Max Profit: Stock moves somewhere north of $145, I keep $230 from the option, plus $725 from the stock gains (if it gets called away for $145 less the $137.75 cost), total $955.
Max Loss: Assuming TGT goes to $0, I'll lose the $13,775 I put into the stock, but I keep the $230 from the option, total loss $13,545.
But it is VERY unlikely that TGT will go bankrupt between now and 9/18. And yet we have to tie up $13k in capital on the play, to hope for a 7% max gain.
Or
2. Naked Put option
I can sell a 145 TGT put with a 9/18 date for $11.60. I don't have to buy any stock. If I want it to be cash secured, I have to keep $14,500 in my account to be able to buy the shares (but since I get $1,160 from the option, I only have to start off with $13,340 in my account). Which means I need $205 less in my account than the covered call option.
Max Profit: If the stock moves somewhere north of $145, I keep the $1,160 from the option.
Max Loss: Assuming TGT goes to $0, I'll have to buy back the shares that are worth $0 for $145, for a loss of $14,500. But I keep the $1,160. Making for a loss of $13,340.
Cost: $13,340 (stock price at $145 to keep it cash secured, less what I will receive from the option).
So the naked put allows me to have a greater max profit ($1,160 vs $955), lower max loss ($13,340 vs $13,545), and lower out of pocket cost up front ($13,340 vs $13,545). And it's the same underlying movement of the stock. But since I have less out of pocket, and greater profit, my potential gains are 8.7% (rather than the 7% for the covered call).
Now consider the use of a margin account. To do the covered call on margin requires a $13k loan from your broker, which is very risky, expensive, and in my opinion dumb. So you need $13k in cash to tie up into the investment. But for the naked put, you don't need all $13k tied up in that trade, sitting in cash waiting for TGT to go bankrupt (which isn't likely to happen). All I need is ~$3,800 in cash in my account (roughly 20% of the stock price, plus the option premium) and I can sell the put. And the max profit is the same. But $1,160 gain on $3,800 of cash is a 30% gain (instead of an 8.7% gain).
So, if I had $14,000, I could tie up $4,000 to sit in cash on the naked put (in the event TGT dropped 30% in the next 30 days), and then I could put $10,000 in other investments (bonds, for example). If I gained anything on the other investments, it adds to my profit. And if I chose a diversified investment for my other option, I'm even further reducing my risk. If TGT drops more than 30% in 30 days, I can pull out of my other investments to cover the loss and buy back the stock.
Considering the naked put and the covered call is the same play on the same stock moving in the same direction, it surprises me that the naked put isn't talked about to beginners as often as the covered call. Especially when the profit is slightly higher, and the max loss is slightly less. Considering I wished I knew this earlier, I just figured it would be worthwhile to talk about it here.
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I initially bought options that would do well in a recovery, but recently added calculations for break even and a halfway recovery. I'm willing to give up some "full recovery" profit to improve my results in other scenarios.
I wound up selling my Macy's $10 calls and buying Macy's $8 calls ("rolling down"). A full recovery might see Macy's stock go from $6.50 to $16.60, gaining +155%. But if it only recovers halfway (maybe from Covid-19 uncertainty or Amazon taking market share)... the $10 calls are just above break even (+20% profit or so) while the $8 calls might double (ignoring time value). For me, "rolling down" reduces the risks associated with a partial recovery.
My overall plan is to await vaccines / treatments and a recovery from Covid-19. In the first week of June, Macy's stock rose +50%. I'm guessing vaccine news could have a similar effect, perhaps larger.
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Thought this might be of interest. I've closed some recent trades and opened a new one today. Not all were winners. I took a 37% hit on DHI. I might make up to 101% on MSFT. Not covered in the piece but September is on pace (all positions in the money) for 1,986 in profits on 5,564 capital at risk on bull spreads and another 3,132 in profits on a covered call position in NLY.
[url]https://velociraptor.cc/blog/2020/08/31/bull-call-spread-with-yield-up-to-783/[url]
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emboldened by this thread, I've spent much of the month short a put-contract on $JPM. I netted $108 on the sale, and I'm only 4.25 trading days away from the contract expiring. Goal is to duplicate @Financial.Velociraptor 's stated Cash-on-Cash return of 1%/month.
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emboldened by this thread, I've spent much of the month short a put-contract on $JPM. I netted $108 on the sale, and I'm only 4.25 trading days away from the contract expiring. Goal is to duplicate @Financial.Velociraptor 's stated Cash-on-Cash return of 1%/month.
@talltexan
Are you playing JPM because you want to earn it long term or because you like its short term prospects? How far did you go out of the money and why? I think it will help others to follow the thinking of a new trader.
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I'm used to seeing it in the news and believe it's a better run bank than some others. I don't think my study here would withstand a ton of scrutiny from this crowd. It also matches my son's initials.
If something goes wrong with the experiment and the shares get assigned to me, I could live with it or sell and continue the strategy.