Options Mentoring

[wayneL]

Ahem.....er, well I'm not really comfortable with that term. But this is a follow on from Tech/A's expertise thread, where there was a lot of interest in options.

Some of us here have some experience....so lets just say "sharing what we know".

Firstly, options are a vastly complex subject. What I know has been slowly added to over the last few years and I don't think it is something that can be absorbed quickly...at least not for us booze addled old farts.

That complexity is what makes them so useful...yet dangerous.

Useful, because you can construct a situation to take advantage of whatever view of the market you have. Indeed , you must have a view of where the market is headed, even if that view is merely "somewhere" or "nowhere".

Dangerous, because of the leverage and strange price behaviour (strange if you have not studied enough). Options have so many "gotchas" it's mind boggling and you are trading against the smartest ****holes in the universe, bar none...the market makers!

They do not have to be dangerous though, they can also be the most effective risk control tool.

It's a bit like handleing stallions. They have the wherewithall to rip your head off your shoulders, and in the wrong hands they have done just that. In the right hands they are your best friend and a joy to be with. Just never take your eye off them LOL

[wayneL]

A couple of free resources:

1/ If you click on my website link below, there is a free download for Charles Cottle's book "Coulda Woulda Shoulda". Charles has been a US options market maker for 25 odd years. It's a hard read, but in my opinion its the best book available.

Might be a bit advanced for some, so beginners should start with one the books by Bower or Tate or similar.

Try to get a solid grasp of the Greeks. Ignorance of these will be at you peril. Some of the seminar wombats are teaching that all this does not matter. Ther students wonder how there bought call option is in loss when the stock is up....hmmm go figure.

Any questions on the greeks are most welcome, I'll try and confuse you even more...er, less...or sumthin' :)

2/ http://www.hoadley.net/options/strategymodel.htm This is a free strategy modeller which will give you payoff diagrams and you can play with different strikes, expiries, etc example as below.

[wayneL]

US market vs Aussie market

Apart from far greater choice and liquidity, the US market has two great avantages.

1/ Cost - brokerage is much cheaper

2/ You can trade ANY position online...any spread you can dream up, naked calls...anything.

Enouigh for now, avagoodweegend

P.S. This is not a monopoly, so join in all you options guys :)

[DTM]

Thanks for the information Wayne. I have three questions:

1. Could you give us the effects of the greeks

2. What the market makers do and how they can affect the market ie by moving the market and their pricing models via greeks.

3. Some basic strategies you would use with different situations

Thanks in advance. :)

Have a good weekend too. :bigthumb:

[tech/a]

Thanks Wayne looking forward to some good discussion.

Perhaps a glossary of terms would be an idea as they come up
coupled with a fairly concise explaination.

Wonder if Joe can have a
single screen that can be added to as a term pops up rather than a thread which would have a glossary all over the place.

Thanks again---where would you like the banana's delivered?? (hahaha) :sly:

[Joe Blow]

Wonder if Joe can have a
single screen that can be added to as a term pops up rather than a thread which would have a glossary all over the place.

Tech, I'll see what I can do.

[doctorj]

Perhaps we should set up a trading/investment Wiki to cover all related subjects including options. See http://wikipedia.org/ for an example. It's format is probably better suited to the task than using a forum as it links questions with answers more effectively and makes searching more efficient.

[positivecashflow]

Option Greeks:


Theta: Change in the price of an option with respect to a change in its time to expiration (time value).

Vega: Change in the price of an option with respect to its change in volatility

Delta: Change in the price of an option relative to the change of the underlying security.

Gamma: Change in the delta of an option with respect to the change in price of its underlying security.

Rho:
Rho is the change in option price given a one percentage point change in the risk-free interest rate.

ASX Link to explain greeks in more detail:

http://www.asx.com.au/investor/options/greeks.htm

[positivecashflow]

Example of Greeks for a trade:

[wayneL]

Yes the greeks are where we should start and the definitions are all over the internet. The ASX definitions that Pos posted are, in my view both overly simplified and overly technical. I could never understand the standard definitions in a practical sense.

I hope to define them, and use examples in more understandable language...a tall order. :(

I also like to lump in Implied Volatility with the greeks even though, strictly, it is not one of them.

Rho we can safely disregard in a stable interest rate environment...but be sure to fill in the correct risk free rate in your strategy modeller....5.75% I believe...close enough!

I like to separate them into two groups 1/ delta and gamma 2/ theta, implied volatility(IV) and vega (also known as omega)

[wayneL]

Lets see if I can cut through the confusion....

Delta:

As Pos posted - Change in the price of an option relative to the change of the underlying security.

Lets suppose we own some at the money call options in Delta Omega Gold LTD (DOG). The price we payed doesn't matter for the purpose of this example.

So lets say DOG moves up 15c during the days trading, but we notice that the options have only moved up 8c. The option price has moved up only 55% as much as the underlying.

This, my friends is what delta measures and is expressed as such- 55% - easy! It may also be expressed as a decimal i.e. 0.55.

Delta expressed as a plural (deltas) means the total exposure of the entire position. For example, if you have 10 US contracts (or 1000 options or 1 aussie contract) you will have 550 deltas...delta x total number of options.

OK, delta also changes depending on whether it is "in the money" (ITM), "at the money" (ATM) or "out of the money" (OTM)

As we go further ITM the delta will increase until we get to a maximum of 100% or 1.0. An option with a delta of 100% will be WAY deep in the money...and if the share moves 10c the option will move 10c

Conversely, the further out of the money we go the lower the delta with a minimum of nearly 0 when way the %$#@ OTM.

This is why if you own OTM options, although cheap to buy, the underlying will have to move a LOT before the option moves.

With put options delta is always expressed as a negative number (eg -55%). The reason is simple. If you own a put the value moves in opposite direction to the underlying, share goes up, put goes down and so on.

Implications of Delta.

If you have bought an ATM call option and the share is going up your profit will inrease at a faster and faster rate until delta reaches 100%

If the share is going down, you will be losing money, but at a slower and slower rate, until delta reaches 0, which happens to coincide with the amount of money you paid for the option.

This is the reason a straddle can be profitable but more about that later...we will also talk about "delta neutral" later.

So how fast does delta change? This is what gamma measures.....

[wayneL]

Gamma:

Pos says: Change in the delta of an option with respect to the change in price of its underlying security.

We have already seen that an ATM call has a delta of around 50 - 55%, and that as the share price goes up delta increases, and decreases as it goes down. (remeber puts have negative delta)

How quickly this occurs is the measurement of gamma.

Some option traders who are very mathematically inclined, like to quantify gamma. I don't think it's necessary, but I do think it's important to know when and where gamma is at is maximum and what effect it has in a relative sense.

Gamma is greatly affected by implied volatility (we talk about that later). When IV's are very low the maximum gamma is ATM. As IV inreases, maximum IV moves ITM, so when IV's are very high maximum gamma may be a long way ITM.

Why is this important? If we are buying options, either alone or as part of a spread, it helps us select the best strike price. We want high gamma in our bought options.

There is another effect of IV on gamma. Gamma decreases as IV goes up.

This means that when IV's are very low, delta will change VERY quickly, and when they are high, very slowly.

Why do we want to know this? Well as an example; if you want to construct a delta neutral strategy such as a long straddle, we want IV's as low as possible so that the high gammas will take us into profit more quickly.

Incidentally the effect of time til expiry has the same effect on gamma as IV. Longer time til expiry - same as higher volatility and visa versa.

.....I don't know whether I've managed to simplify that or not.....hmmmmmm Perhaps I should have done implied volatility first, but that's next :-/

[markrmau]

Thanks for the info in this thread Wayne. I was hoping that after the explanation of terms / strategies, you or someone else could provide a real life demonstration about what you are thinking as you enter/exit a trade.

Also I note that this discussion is also valid for ASX trading warrants (except you can't write your own warrants). The advantage with the trading warrants is that if anyone has a mechanical system they want to back test, the warrant OHLC data is freely available through www.float.com.au - I couldn't find historical option prices though.

[tech/a]

Mark.

Im sure Wayne will get to this.
There is enough to absorb as it is!

Wayne I found your

WHY this is important or WHY we do this as very informative.
I know its a bit painful but Highlighting these gems as bullet points saves scrolling and reading.

[wayneL]

Yes will get into some examples later, but there is a bit to get through yet.

This post is about intrinsic value, extrinsic value and implied volatility.

Intrinsic value is the amount of value an option is "in the money", simple as that. Consequently, ATM and OTM options have no intrinsic value.

For example, if you own some call options with an exersize price of $30 and the underlying is trading @ $32, you own ITM call options. If the option expires with the underlying at $32, your option is worth $2, because you can exersize that option and buy a $32 stock for $30. This part is easy because it is readily quantifiable. (sorry if this is a bit basic for some of you but it is important for my point)

Extrinsic value is the market price of an option in addition to the intrinsic value. ATM & OTM options ar ALL extrinsic value because they have no intrinsic value. If in the example above the $30 call option was trading at $3.50 when the underlying is trading at $32, then we have $2 of intrinsic value and $1.50 extrinsic value. This extrinsic value is the puzzling part for the novice.

So how is extrinsic value priced? Some more explanations, then we get into that.

Most people refer to extrinsic value as time value. I don't, because time is only part of the picture. It is true that extrinsic value "tends" to go down as time goes by, but there are anomolies in option pricing that time does not explain.

Consider this example:

We have two mythical stocks, DOG and BARK both trading at $43.50

The DOG call options are trading @ $0.95 with 2 months to run.

The BARK call options are trading @ $3.55, also with 2 months to run.

To add to the confusion, a month ago the BARK options were trading for $2.70 when the underlying was at 43.50...cheaper yet with more time left than now.

WHY?

Enter Implied Volatility:....

[wayneL]

So what is volatility?

Investopeadia days: A statistical measure of the tendency of a market or security to rise or fall sharply within a period of time.

We can measure volatility retrostectively by using a formula (which I can post if anyone wants) which will give us a percentage figure. This is refered to as Statistical Volatility

So if a stock is relatively stable and sedate, it's volatility may be around 15% or so. If a stock tends to bounce all over the shop very quickly it could have a statistical volatility of 50% or even much much higher.

So how does this affect option pricing?

This all goes back to extrinsic value. This extrinsic value reflects the risk taken on by the option writer (seller) that the option may expire ITM...and the risk that is may expire FAR ITM resulting in a loss for the writer. It is a "risk premium" not unlike insurance premium.

Think about it, time = risk, and volatility = risk...both together = big risk.

The more time left on the option the more chance that circumstances may push the underlying deep into the money....risk for the writer.

If you have a very volatile underlying, who knows where the hell the price will end up on expiry....risk for the writer.

Using the black-scholes option pricing model, using algebra, we can work out what volatility is priced into the option premium. But this my not reflect at all the statistical volatility of the underlying. It may be cheaper or one helluva lot more expensive than indicated by the recent past.

Why is this so? Often it is explained away as being underpriced or overpriced. But it is not this at all. It is the the perception of possible future volatility and therefore the risk to the option seller during the life of the option. This is called Implied Volatility.

Lets look at an example; WOOF is a biotech that has been plodding along in the market, not really going anywhere, and has a statistical volatilty of say, 20%. But it is known they have been working an a miracle drug promising eternal youth and the results of an extended trial are due out in 4 weeks time. When the results are released, it could mean a dramatic move to the upside or downside.

If you were an option seller, would you be selling WOOF options at supposed "fair value" of 20% volatiltiy.

NO BLOODY WAY MATE! The risk you are taking on, you might want 150% as it is likely to be a humungous gap when the news is released. We just don't know which way!

So just to repeat, Implied volatility(IV) is the markets guess of future volatilty.

There are other aspects to IV such as "Volatility Skew" and "Volatility Crush", which we will go into later.

Cheers

[positivecashflow]

Here is an example of Volatility Skew and Volatility Crush plotted on a graph. As wayne will probably explain, different expiry periods of options have different implied volatility levels. The difference is due to the expectations of traders and MMs that an option will move in the period specified. eg if WOOF was coming out with an announcement in 3 days that was expected to make the share price jump, then obviously the IV would be higher for options that expire near term and thus the options will increase in price (maybe due to demand).

The first image depicts a huge "volatility skew" that existed between options that expired 7-30 days away (the red line) and longer term options that expired > 90 days away (black line). Maybe traders and MMs expected the stock to move in the future rather than near term. This is all maybes at this point.

The second image depicts a drop in the IV for the longer term options (black line). This is known as volatility crush, where the IV drops and the option loses value (as wayne explained IV is priced in the options).

There are various strategies that you can employ to play volatility skews, crushes and rushes (where IV rises and your bought options increase in value even if the stock does nothing).

It is important that you manage IV effectively in your positions so that you make the most in the changes in the IV priced in options.

Back to you wayne.

[wayneL]

It is important that you manage IV effectively in your positions so that you make the most in the changes in the IV priced in options.

That deserves to be in bold!

It is important that you manage IV effectively in your positions so that you make the most in the changes in the IV priced in options.

IV can be a huge trap for the unwary and a great opportunity if you know what to do with it.

Good stuff Pos!

[wayneL]

Vega (sometimes known as Omega) is the effect on option prices from changes in Implied Volatility.

Like Gamma, I don't bother to quantify Vega (you can if you have a superhuman mathematical brain). But like Gamma it is necessary to know where vega has the greatest effect.

Vega has the greatest effect when At The Money and diminishes the further you get away from the money.

So what this means is, if you have bought an ATM option at high IV's ( which you want to avoid like the pox, unless as part of a spread), you're praying that IV's don't decrease, because it's gonna hurt. It will hurt less so if your option is away from the money. Conversely if you bought an option at low IV's, you don't care if IV goes up because it's to your benefit.

Example: MEOW is trading at $25 with option IV's @50%, and for some inexplicable reason, you buy the $20 call for $5.50, the $25 call for $2.15, and the $30 call for $0.65

For some equally inexplicable reason IV's fall to 40% during the day, and the price hasn't changed. This is what happens:

$20 call goes from $5.50 to $5.35, you lose 15c
$25 call goes from $2.15 to $1.75, you lose 40c
$30 call goes from $0.60 to $0.35, you lose 25c

So we can see here that vega is greatest ATM.

It's clear why we want to know this, If we're buying options we want to buy at lower end of an options IV' range so that vega will work in our favour ...and of course the opposite if we're writing options.

One more point, vega decreases the nearer we get to expiry.

One more greek to go... Theta

[seaurchin]

hi wayneL & tech /a and other traders...thanks for the interesting information on options etc.
I have only been paper trading and was successfull inside 2weeks.
so i went in and bought bhp calls monday sold tues. 20% gross profit.

However, I have good relationship with broker and trust him.

My question is I have only the use of ASX.site which is 20 minutes delay or so
Normally as you know you have m/depth to help see the supply demand of stocks instantly...ASX options I see open interest and volume only.

Is there a site which can have this info. faster and market depth.
thanks for your help. :confused:

[tech/a]

Fraid youll have to pay for live data.

I use Marketcast.$165/mth (SBS feed)
Think Bullcharts is $145/mth(Internet Feed)

[wayneL]

hi wayneL & tech /a and other traders...thanks for the interesting information on options etc.
I have only been paper trading and was successfull inside 2weeks.
so i went in and bought bhp calls monday sold tues. 20% gross profit.

However , i have good relationship with broker and trust him.

My question is i have only the use of ASX.site which is 20 minutes delay or so
normally as you know you have m/depth to help see the supply demand of stocks instantly...ASX options i see open interest and volume only.

Is there a site which can have this info. faster and market depth .
thanks for your help. :confused:

Yep, as tech/a says you will pay handsomely for live data. One other source which may be less expensive is www.sanford.com.au

As far as market depth is concerned, I think with options it is totally irrelevant....particularly with aussie options where in 99% of cases, the market maker is on both sides of the bid and ask.

So you either hit the bid/ask, or place your order and wait to see if the market comes to you.

Cheers

[money tree]

comsec has good free options data

I never pay the ask or sell at the bid. Divide the spread and place your order in the middle.....eg:

spread 20/24

put order in @ 22

90% of the time you will be filled within 2 mins. The slightest volatility of the underlying will get you a fill.

[seaurchin]

THANK YOU VERY MUCH FOR THAT ADVICE FROM BOTH OF YOU.
M/depth ..well that is good then as it does help me make decision on intraday trading sometimes in bullish market buying shares.
Options ...as you suggest irrelevant market makers both sides.
Could any of you offer an opinion on what to buy next?
or is this time to wait on sideline?
much appreciated for your time. I will look to find a BUY and study and shall post it and ask for opinion ..hope that ok.cheers

[eddievanhalen]

Gday Wayne - I'm not an options traders as such but have a basic understanding. Well done on the thread etc..........just thought I'd point out a typo to avoid confusion for the newbies

Post #15 you said "Most people refer to intrinsic value as time value." when you obviously meant extrinsic.

Cheers,

Ed.

[wayneL]

Gday Wayne - I'm not an options traders as such but have a basic understanding. Well done on the thread etc..........just thought I'd point out a typo to avoid confusion for the newbies

Post #15 you said "Most people refer to intrinsic value as time value." when you obviously meant extrinsic.

Cheers,

Ed.

Ah yes, thanks Eddie. Perhaps Joe could correct that for us.

Thanks in advance. :)

[RichKid]

Ah yes, thanks Eddie. Perhaps Joe could correct that for us.

Thanks in advance. :)

I think I've fixed it (post #15), let me know if I stuffed up.

BTW, is there somewhere I can get graphs like the ones shown by Pos for IV?? Are there free tools? I just use Comsec protrader2 and it's pretty basic for options but does have an option price calculator, don't know how good it is though. What do the guru's think of that price calculator?? Is it what they call 'fair value'? It shows my IV and the greeks with some variables like, time to expiry etc so I can fiddle with it a bit.

[DTM]

I think I've fixed it (post #15), let me know if I stuffed up.

BTW, is there somewhere I can get graphs like the ones shown by Pos for IV?? Are there free tools? I just use Comsec protrader2 and it's pretty basic for options but does have an option price calculator, don't know how good it is though. What do the guru's think of that price calculator?? Is it what they call 'fair value'? It shows my IV and the greeks with some variables like, time to expiry etc so I can fiddle with it a bit.

Rich, where do you find that feature?

[RichKid]

Rich, where do you find that feature?

Hi DTM,
Which one? The options calculator? It's free with Protrader 2 (released last week). Go to the prices menu at the top toolbar (top left corner of screen): Prices-Exchange Traded Options- ETO valuation calculator. Pretty nifty, just don't know enough about options to know what to make of it. Thanks to Wayne, Pos, Guy Bower, Chris Tate (and you!) that should soon change.

Anyone who doesn't have Protrader2 can see a demo of it on the www.commsec.com.au website- it'll have a sample of how the calculator works. You only need to place one options trade per quarter to get it free so I'm stoked about the money I'm saving (since I manage to lose so much!).

[wayneL]

The last greek is Theta

Most people will recognise this as Time Decay and is the theoretical amount that the value of an option will reduce in a day, all else being equal.

I DO like to quantify Theta and this is easily done in the strategy modeller by going to the position greeks menu and selecting theta. It will show you the theta in dollars for the whole position.

Lets think about why theta exists. We talked about "risk premium" above when we discussed extrinsic value and how time equals risk of the option expiring ITM. So logically each day that goes by means one less day of risk for the option writer. So risk premium reduces as time goes by...hence decay....easy.

As with the other greeks, it is handy to know when and where theta is greatest and least.

Theta is greatest when the option is ATM and, quite obviously, is higher the further away from expiry.

The higher the IV of an option the greater the theta.

We are told that Theta increases the closer to expiry it gets and ramps up considerably in the last 30 days in the life of the option. But this is only true ATM or near the money. Away from the money theta DEACREASES as time goes by.

Theta decreases the further away from the money you get. So as delta approaches 100% or 0%, theta is almost zero, even in the last few days.

The reason we want to know about theta is the most obvious of all the greeks. We want to know how much it is going to cost us to hold bought option positions and what we gain in return for taking on the risk of holding short (written) option positions; and so helps in the management of those open positions...exits etc.

Thats the last of the greeks. Next We go into a little more detail about Implied Volatility, then onto strategies.

Cheers

[wayneL]

More about Implied Volatility....

Earlier I described what IV is, but IV has some nuances that the option trader should know about. This knowledge, at the very least, will save you some losses and can also lead to easy profits if one knows what to do with it.

Firstly, most technical traders will know that periods of low volatilty will follow periods of high volatility, and that periods of high volatilty will follow periods of low volatility. In other words, volatility tend to cycle up and down. This is measurable statistically via standard deviation equations.

"Implied Volatility" tends to somewhat mirror this statistical volatility in most cases.

How does this help? Well as IV is priced into the option, it may be an indication of when we should be buying and or selling options. The old addage of "buy low, sell high" applies to IV as well.

In other words if IV's are high, it would not be an ideal time to be a buyer of options. Not only will theta be higher, but you may be faced with declining IV's and therefore a rapidly decreasing extrinsic option value. This means you have to be VERY right. Even if you are right about your view of the market, but not right enough, you may STILL LOSE.

On the other hand if you buy options when IV's are in the lower quartile of there IV range, you may benefit from INCREASING IV....maybe enough to completely negate theta.

Of course the opposite applies when writing options.

The second little nuance of IV, is "Volatility Skew"

Volatility skew comes in two flavours price skew and time skew

Price skew is when the IV of options of the same expiry date but different strike price are higher/lower. that is to say that they are skewed.

Typically, IV's will increase the furthar away from the money you get. This is often refered to the "volatilty smile" because of the shape of the IV's plotted on a graph.

Time skew is when the IV of options of the same strike price but different expiry are higher/lower. For example, at the time of writing, June ATM IDCC call options are trading at 118% whereas the Jan '06 options are trading at 53%.

Time skew is a little harder to find than Price skew, but represents a golden opportunity to lay on some low risk, high probability spreads.

[wayneL]

That's enough confusion for this thread....unless there are any questions, I'll move on to something else........

Cheers

[wayneL]

Here are some ioption quotes for IDCC that clearly show both time and price volatility skew....implied volatilities are in the red box marked.

Cheers

[dutchie]

Wayne, thanks for a great thread.

Would you be able to give us a few examples (using real values) of the use of the different greeks. I understand what each greek represents but am a bit fuzzy as how they can be used in trading (or not trading).

Thanks, Dutchie

[hissho]

time to update this post......

where can i get that "ioption" wayne?

cheers

[wayneL]

time to update this post......

where can i get that "ioption" wayne?

cheers

:o "ioption" should simply read "option", a result of fat fingers... apologies for the confusion.

The screenshot is simply interactivebrokers option quote platform... part of their Traders Work Station.

Cheers

[wayneL]

I also like to lump in Implied Volatility with the greeks even though, strictly, it is not one of them.

I have always lumped in volatility into the greeks even though it doesn't have a greek name. But I have discovered (or rather realised) that it does.

The measure of 1 standard deviation as an annualised figure (commonly known as implied volatility) is an input into the BSOPM. This measurement in fact has a greek name - SIGMA.

Happy at last, IV is a greek after all LOL

[hissho]

thanks Wayne! no wonder google got nothing when i tried to search "ioption"...

2 quick questions:
1) where can i find "cws"? can u put it on your website or email me?
2) if i don't have access to brokers option quote platform, what can i use to find out greeks and SV and IV?

thanks a lot in advance
hissho

[wayneL]

thanks Wayne! no wonder google got nothing when i tried to search "ioption"...

2 quick questions:
1) where can i find "cws"? can u put it on your website or email me?

I'll email it to you. PM me your email.

2) if i don't have access to brokers option quote platform, what can i use to find out greeks and SV and IV?


The option strategy modeller mentioned at the start of this thread will give you all the current greeks... including "sigma" (IV hehe). The derivatives add-in will calculate SV as well.

What markets are you looking at... ASX or US? Then I can tell you where to get IV and or SV history. Generally, You can get US IV/SV data for free from www.cboe.com. AUS data you generally have to pay for, or have webiress.

Cheers

[Magdoran]

Hello Wayne,


I’m pleased to see the great job you are doing with options. You’ve come a long way indeed from when we chatted on the SG site a few years ago about options, well done!

So, are you trading options in the US mainly, or Australia, or both? I also note you made some comments on silver on another thread, are you trading options on futures too?

I’m curious about what kind of strategies you’re into these days too... like are you doing any ratio positions, perhaps with mixed strikes and mixed expiry dates? Pretty amazing what you can do, isn’t it?

Anyway, I hope you don’t mind me posting a few observations and slightly alternative viewpoints on your thread for general interest.

Top marks for the initiative!


Regards


Magdoran

[Magdoran]

Key Option Concepts: DELTA

This might simplify some of the concepts above:


Delta: The rate an option will change in value in proportion with the underlying.

• Calls have positive delta – expressed from +1 to 100 (% to underlying movement)
• Puts have negative delta – expressed from -1 to100 (% to underlying movement)
• At the Money options typically have a +/- delta of 50
• Way out of the money options have low deltas
• Deep in the money options have high deltas.

Increased volatility – call deltas move towards +50 and puts towards -50
As time passes – call deltas move away from +50 and puts away from -50


Hope this helps


Magdoran
P.S. Based on Sheldon Natenberg "Option Volatility and Pricing"

[Magdoran]

Key Option Concepts: GAMMA

This might simplify some of the concepts above:


Gamma: The rate an option’s delta changes as the underlying price changes.

• Gamma is expressed as +/- delta points gained/lost when the underlying rises/falls
• Calls and puts must have positive gamma.
• Gamma of an ATM option can increase dramatically as time moves closer to expiry, or volatility decreases (or both).

As time to expiration is increased and/or volatility is increased, options tend to become more ATM, with call/put deltas approaching +50/-50.

As time to expiration is decreased and/or volatility is decreased, option call/put deltas tend to move away from +50/-50.

An option which is ITM will tend to move further ITM, and an OTM option will tend to move further OTM. ATM options with deltas near 50 tend to maintain delta despite time and volatility.

ATM in this case assumes the option most likely to end near the actual underlying price at expiration, and assigns a value of around +/- 50 to it.



Hope this helps


Magdoran
P.S. Based on Sheldon Natenberg "Option Volatility and Pricing"

[wayneL]

Hello Wayne,


I’m pleased to see the great job you are doing with options. You’ve come a long way indeed from when we chatted on the SG site a few years ago about options, well done!

So, are you trading options in the US mainly, or Australia, or both? I also note you made some comments on silver on another thread, are you trading options on futures too?

Hi Magdoran,

Welcome to ASF, your contributions will be a bonus for members here :)

I am trading exclusively US options, and moving steadily over to futures options (as well as straight futures). Though will always try to have a hand in the stock market till.

There are several features of futures options that I am enjoying a lot, not the least of which is margin requirements. SPAN rocks.


I’m curious about what kind of strategies you’re into these days too... like are you doing any ratio positions, perhaps with mixed strikes and mixed expiry dates?

I'll put on any and every strategy. First point of analysis is IV/SV, then market view, various black swan scenarios and go from there. I'll lean towards the simplest strategy that will get the job done initially, and will leg in to more complex stuff if required for defence & or optimizing. This may include ratios mixed strikes/expiries etc.[/QUOTE]


Pretty amazing what you can do, isn’t it?

Indeed. I've ended up with some pretty creative positions from time to time. I've been an active campaigner for folks thinking beyond what some of the more asinine seminar presenters teach as "magic moo cows" and similar silliness (all fine strategies in their rightfull place, but not the traders panacea as presented)


Anyway, I hope you don’t mind me posting a few observations and slightly alternative viewpoints on your thread for general interest.


Fire away!! This game is so multifaceted that there is ALWAYS an alternative viewpoint. Re-reading through this thread, I also have alternative viewpoints to myself! LOL

Open discussion on options is "class A" learning IMO.

Folks,

Mag' knows his stuff, so listen up.

Cheers

[Magdoran]

US Market Vs Australian Market


I’d like to give a slightly different perspective on the appraisal earlier on the thread.

A lot depends on your trading style and preferences. Yes the US market is more liquid, but there is a subtle reason for this other than just more volume being traded per se.

What a lot of new options traders fail to grasp at first is the difference in gradation of the strikes. The US stock option gradation of strikes is either at $2.50 or $5.00 increments, while in Australia it is at $0.25 or $0.50. This is why each strike has potentially more open interest there because the range of choices is very limited.

So why is this important you may ask? Well, when selecting precise options based on a price and time objective, the risk and reward parameters become very different when you can select a strike which is likely to finish in the money at expiry as opposed to out of the money. This can mean a great deal of difference in risk/reward (a US return for a similar stock move could be say around 50% - 150% where in Australia depending on a range of variables you may make the same, or well in excess of this range – perhaps as high as a 500% return for a similar percentage move in the underlying).

Another factor is that the option value increments for US stock options is set at 0.05 (5 cents) as opposed to (half cent) 0.005 gradations for Australia (that’s 10 times as fine – this is significant to many positions, especially if you want to exit a loser).

Also, the volatile movement in the US can see the underlying jump past your preset contingent orders, and unless you trade all night (or get up early to adjust in the morning before 6.00 AM during winter), you can wake up the next day to a huge loss. Using market orders for contingent sell orders is probably the only way to ensure you get a fill, but at the real risk of getting a paltry sum for your position on stoploss contingent orders – especially vulnerable to intraday spikes.

The main problem in Australia is that there is the lower open interest, and problems with getting set in stocks designated “flex” (where the market maker doesn’t have to provide a market, and only had to show a market for a reduced period at their discretion). You can trade these markets, but the spread is often going to favour the market maker more, hence you’re looking for a high probability trade with sufficient risk reward parameters to justify the spread risk undertaken).

From my experience, you have to keep a good armoury of strategies and tactics to select the right approach for each market. It is important to be aware of these key differences when trading either market.

Hope this is of interest.


Regards


Magdoran

[Magdoran]

Hello Wayne,


Thanks for the welcome, and gratifying to see how much you’ve expanded your capabilities. Futures are an interesting arena, one I more watch than trade currently. I also moved more to the Australian market since I found my performance was better than in the US (I like my sleep – and try not to overtrade). How are you finding the US market at the moment?

I’ve been doing a lot of work recently on hedging strategies combining options and futures (options on futures perhaps more precisely), but it’s pretty involved when you’re trying to work out a range of instruments to work in concert – still getting my head around how to automate this more. So I share your enthusiasm for the breadth of opportunities, the things you can do are almost endless, aren’t’ they?

Nice to hear you are progressing well. Over some time now, I’ve found that sometimes it’s better to keep things simple and not get bogged down in complexity… simple bullish strategies like bull puts when volatility is high combined with longer dated OTM calls and then selling current month calls a strike or two towards the money works well in a bullish market. The danger being that the sold call may end up in the money at expiry, so have to manage these carefully.

The key is, “does it work in reality?”, isn’t it? As T.S. Elliott said “between the theory and the practice falls the shadow”.

Thanks for the salutation too, much appreciated.


Regards


Magdoran

[wayneL]

US Market Vs Australian Market

What a lot of new options traders fail to grasp at first is the difference in gradation of the strikes. The US stock option gradation of strikes is either at $2.50 or $5.00 increments, while in Australia it is at $0.25 or $0.50. This is why each strike has potentially more open interest there because the range of choices is very limited.


This is a good point Mag' and this can adversely affect the flexibility of what you can achieve in the lower priced stocks. Anything below say $15 is generally a waste of effort.

However:

1/ Many US stocks are much higher priced, making those $2.50 - $5.00 (and sometimes $10.00) intervals relatively closer together (in % terms) . Consequently, I look for stock prices with a bare minimum of $20, and generally much higher. This alleviates this interval problem to a large extent.

Also there are the Index tracking ETFs such as SPY DIA IWM and QQQQ, all of which have strike intervals of $1.00. This make these quite sweet contracts to trade. ( there are also true index options as well, SPX OEX NDX etc)

In addition, futures option intervals are much more reasonably spaced. Another reason of my growing fondness for them.

2/ There is vastly more choice of optionable stocks to trade. If the interval is proving to be adverse to your intentions for the trade (and this does happen frequently enough), just move on to something else.



Another factor is that the option value increments for US stock options is set at 0.05 (5 cents) as opposed to (half cent) 0.005 gradations for Australia (that’s 10 times as fine – this is significant to many positions, especially if you want to exit a loser).

My comment regarding this largely reflect my comments on interval. It definately can be a disadvantageous factor, particularly in lower priced shares and WOTM options.

However there is some talk of moving on to 1c value increments. The exchanges are not keen on the idea, but I strongly feel this will happen at some point in the not-too-distant future. This will be a huge improvement when it happens.

**

As always, horses for courses and folks can certainly do well from the OZ options market. On balance though, I personally much prefer trading options in the Evil Empire. Mag' oobviously prefers the ASX. Both have advantages and disadvantages. In the end it may come back to style of trading as to which market is more suitable for an individual.

Cheers

[wayneL]

Hello Wayne,


Thanks for the welcome, and gratifying to see how much you’ve expanded your capabilities. Futures are an interesting arena, one I more watch than trade currently. I also moved more to the Australian market since I found my performance was better than in the US (I like my sleep – and try not to overtrade). How are you finding the US market at the moment?

I’ve been doing a lot of work recently on hedging strategies combining options and futures (options on futures perhaps more precisely), but it’s pretty involved when you’re trying to work out a range of instruments to work in concert – still getting my head around how to automate this more. So I share your enthusiasm for the breadth of opportunities, the things you can do are almost endless, aren’t’ they?

Nice to hear you are progressing well. Over some time now, I’ve found that sometimes it’s better to keep things simple and not get bogged down in complexity… simple bullish strategies like bull puts when volatility is high combined with longer dated OTM calls and then selling current month calls a strike or two towards the money works well in a bullish market. The danger being that the sold call may end up in the money at expiry, so have to manage these carefully.

The key is, “does it work in reality?”, isn’t it? As T.S. Elliott said “between the theory and the practice falls the shadow”.

Thanks for the salutation too, much appreciated.


Regards


Magdoran

One thing I've noticed with professional/successful options players is the vast diversity in the ways in which money can be extracted from the market.

As you know, there are currently 4 greeks that can be traded either with an independant view or in combination with each other (excluding only Rho in this currently stable interest rate environmnt. That could change though)

This makes for a bewildering array of long, short, and neutral combinations of greek positions that can be exploited.

It's like 3d chess and a lot of fun to learn, grasp and implement.

...and the learning never stops.

Cheers

[Magdoran]

Hi Wayne,


All the points you make are valid. You are quite right, it is horses for courses, very much so, and I respect each trader has their own path to walk, couldn’t agree more. That’s the beauty of these instruments – the ability to express each individual’s strengths (and perhaps weaknesses).

The US has vastly more optionable stocks, quite true, and the index and futures options are certainly better graded than the stocks. Fully agree here (I was referring to stocks – no argument about indexes and futures). The problem I do have with the indexes is that it is hard to get a good spread trade based on a range of factors – you rarely see a skew in the strikes for the indexes for instance, which limits opportunities other than to trade straight option positions.

Where the gradations in strikes have an impact is when you compare Australian stocks that are around or above $20 (e.g. COH, MBL, CBA, WPL, RIO) compared to similarly priced US stocks, the potential reward for a similar percentage move in each underlying is different given you can precisely choose a mildly OTM option which moves into the money before your time exit, gaining significantly in raw percentage returns (say 500% as opposed to say %150). Makes a big difference to your bottom line when the market is trending nicely.

The difference also in value gradations can shave value off your entries and exits since you can’t move more finely, and I would argue that this adds up (in the market makers favour). It would be great if the US exchanges embraced a 1 cent standard!

This assumes that the US $5.00 increment strike has a lower probability of moving into the money, and of course the delta on an Australian option that moves into the money (ITM) appreciates significantly as the underlying moves further into the money, hence the major difference in both the potential for significant rewards as well as the probability of success, wouldn’t you agree?

Great chatting Wayne!


Regards


Magdoran
P.S. You’ll be in trouble if my wife sees your comment on the “Evil Empire” – she’s from the US! She’ll probably want to join me on my trip to Perth soon, to wrap you over the head with a newspaper (or one of my options books), so watch out! Hehehe. Mag

[wayneL]

Where the gradations in strikes have an impact is when you compare Australian stocks that are around or above $20 (e.g. COH, MBL, CBA, WPL, RIO) compared to similarly priced US stocks, the potential reward for a similar percentage move in each underlying is different given you can precisely choose a mildly OTM option which moves into the money before your time exit, gaining significantly in raw percentage returns (say 500% as opposed to say %150). Makes a big difference to your bottom line when the market is trending nicely.

The difference also in value gradations can shave value off your entries and exits since you can’t move more finely, and I would argue that this adds up (in the market makers favour). It would be great if the US exchanges embraced a 1 cent standard!

Yes, I can see exactly what you are saying Mag. This perhaps highlights that, depending upon your philosophy of trading, one or the other may be better. I tend to think of my positions in terms position delta, position gamma, defence capabilities and total spread to exit if all goes pear shaped. I also think of profit/loss in terms of total capital, rather than individual positions.

If I am going to initiate a long options position, based on the factors present in my market, I am more likely to go ATM or slightly ITM. Theta is at a maximum at this point, but so is vega and gamma and we are long these. Therefore I am pretty concious of IV levels relative to their recent history and avoid potential IV crush like the pox. In fact I like the potential of IV "rush" and will seek out those opportunities.

Otherwise, If I' keen on a particular opportunity and want a delta position, I'll just spread off straight away.

In general though, unless IV's are low and the outlook is for increasing volatility, I would prefer to have long theta (+) positions.


....and of course the delta on an Australian option that moves into the money (ITM) appreciates significantly as the underlying moves further into the money, hence the major difference in both the potential for significant rewards as well as the probability of success, wouldn’t you agree?

I assume you are refering to higher gamma, due to lower IV in Oz options?

Assuming that realised volatility reflects IV it shouldn't make a helluva lot of difference should it? The higher IV (and therefore lower gamma) stock should move proportionately more, realising simmiar gains in terms of capital employed?


Great chatting Wayne!Yes aways fun getting into the nitty gritty of options :)



P.S. You’ll be in trouble if my wife sees your comment on the “Evil Empire” – she’s from the US! She’ll probably want to join me on my trip to Perth soon, to wrap you over the head with a newspaper (or one of my options books), so watch out! Hehehe. Mag

:eek: I'm a yank originally too, so I'm allowed :D

I'll still remember to duck though... just in case :D

[Magdoran]

Hello Wayne,


So, which part of the states are you from? I suppose you’ve been in Australia for a while then?

Ok, the point I was making about US Vs Australia is this:

Say we have two stocks trading at $40 (hypothetically let’s say DOX and CBA were trading at $40).

We project that each stock will hit $44.50 by 30 days to expiry.

DOX has a $40 and $45 call available ($5 increments).

CBA has literally 14 strikes available between these increments.

I used July calls for both, and added days for the US options to match the theta decay (I set the time to expiry and the entry and exit price to the same numbers for each stock).

I trailed a few different variables, and came up with a range of results where the CBA trade was making around 1000% ROI for several OTM strikes mid way between 40 and 45, while the DOX returns were more like 400% ROI for the two strikes available.

This is consistent with my experience trading both markets. Trading OTM positions is more aggressive, but the rewards are far higher when the trade is correct. Also, the delta effect is less if you are wrong for OTM positions.

I deliberately wanted to make the US look bad however, by selecting a price range which would show up the divergence clearly, so the difference is not always as great, it really depends on the entry and end price, and the time frame.

If the US stock entry and exit line up favourably with the strike prices, the difference reduces. But this range is affected by the width between the strikes, and severely limits the range of strategy choices in comparison, and waiting for the right movement in line with the limitations of the US strikes is restrictive in comparison. Just think it through– 14 strikes available compared with 2. Everyone reading this, please do the math yourself and have a play – see what you find.

Another factor to consider which options model you are using. I prefer American exercise/ Binomial over European exercise Black and Scholes, I think the former gives a more accurate forecast on average.

Admittedly volatility is another key aspect to this equation, and on average the US has had much higher stock implied volatility than in Australia, hence credit positions are generally effective in the US, hence straight calls and puts work better on average in Australia than the Us since the implied volatility has been lower (although of course this can change).

Anyway, this is food for thought, isn’t it?


Happy modelling!


Magdoran

OTM = Out of the Money
ATM = At the Money
ITM = In the Money
ROI = Return on Investment

[sails]

Hi Magdoran,

Welcome to ASF! It is a real pleasure to find someone else with such an interest in Aussie options!

I've been trading Aus options for about 3 years now having started with SPI futures a few years previously. In these 3 years of studying options and lots of testing and strategy experiments, live trading and general observations, I have found the best way for me to make money is simply being long premium but very short term - usually not too far OTM and mostly front month. With some of our stocks being so chronically low in IV, I'm far more comfortable being long gamma. For the short time I'm in a trade, theta is really not an issue. So really interesting that you have come up with similar observations on the Aus options market.

For a long time I tried to make +ve theta work for me in the form of credit type spreads, butterflies and all the variations I could find using Aus options, but without much success. Also worked hard on delta neutral positions so didn't need to know where the stock might go, but in the end got back to work on the charts and let gamma work for me.

I do agree with you that it is great to have so many strikes on higher priced shares - but did you know that the ASX stated some time ago now that they are changing CBA, RIO and MBL to $1 strikes? CBA usually only averages a $2 range per month (exception this month!) so it will take the shine off it a bit. I have noticed now that any new strikes added are in $1 increments - already started in June with 4050 being the last 50c strike. Can understand with RIO and MBL being much higher priced shares, but think it's a bit mean on CBA.

Cheers,
Margaret.

[wayneL]

Hello Wayne,


So, which part of the states are you from? I suppose you’ve been in Australia for a while then?

I'm from the "New" New Mexico. i.e Southern California. And yes I've been here long enough that my relatives no longer understand a word I say! LOL


Ok, the point I was making about US Vs Australia is this:

Say we have two stocks trading at $40 (hypothetically let’s say DOX and CBA were trading at $40).

We project that each stock will hit $44.50 by 30 days to expiry.

DOX has a $40 and $45 call available ($5 increments).

CBA has literally 14 strikes available between these increments.

I used July calls for both, and added days for the US options to match the theta decay (I set the time to expiry and the entry and exit price to the same numbers for each stock).

I trailed a few different variables, and came up with a range of results where the CBA trade was making around 1000% ROI for several OTM strikes mid way between 40 and 45, while the DOX returns were more like 400% ROI for the two strikes available.

This is consistent with my experience trading both markets. Trading OTM positions is more aggressive, but the rewards are far higher when the trade is correct. Also, the delta effect is less if you are wrong for OTM positions.

I deliberately wanted to make the US look bad however, by selecting a price range which would show up the divergence clearly, so the difference is not always as great, it really depends on the entry and end price, and the time frame.

If the US stock entry and exit line up favourably with the strike prices, the difference reduces. But this range is affected by the width between the strikes, and severely limits the range of strategy choices in comparison, and waiting for the right movement in line with the limitations of the US strikes is restrictive in comparison. Just think it through– 14 strikes available compared with 2. Everyone reading this, please do the math yourself and have a play – see what you find.

Another factor to consider which options model you are using. I prefer American exercise/ Binomial over European exercise Black and Scholes, I think the former gives a more accurate forecast on average.

Admittedly volatility is another key aspect to this equation, and on average the US has had much higher stock implied volatility than in Australia, hence credit positions are generally effective in the US, hence straight calls and puts work better on average in Australia than the Us since the implied volatility has been lower (although of course this can change).

Anyway, this is food for thought, isn’t it?


Happy modelling!


Magdoran

OTM = Out of the Money
ATM = At the Money
ITM = In the Money
ROI = Return on Investment

Cox, Ross & Rubinstein all the way :)

Ok your scenario is most certainly true for a certain set of conditions. For those figures to works as posted:

*IV would be lowish... say ~15% or less.
*A $4.50 move would be a move not indicated by IV. I'm guessing it would be > 2 sigma, perhaps > 3 sigma. In other words a big move for this stock(s) (without knowing the exact time frame we are speaking of)
*Higher IV's would temper this markedly

Now I have a couple of problems with OTM options... and one of them IS more apparent in the US market.

*Position size would need to be increased exponentially the further we get away from the money to maintain position Delta
*Contest risk (transaction costs plus entry/exit spread) is increased... already double at 42.50 strike. This alone destroys any advantage OTM has with the range of returns that are within the high probability range. The move MUST be strong
*We are moving INTO or THROUGH an area of maximum theta, and beacuse of inreased position size, time will be of the essence. The longer we take to get to target the more or ultimate profitability is compromised. This may be alleviated by vega, but we don't know that.
*We don't get the benefits of gamma until we get a substantial move. The more probable range of returns will not benefit hardly at all.

All that said though, if the stock moves even further... say $45 -$48 You will kick one huge goal with the OTM call.

At the end of the day (or more accurately, at the end of the year) it is all comes back to the expectancy equation to see which is better. Because we are dealing with a highly chaotic subset of market dynamics, this can only be done accurately in parallel and in retrospect on real returns.

What tickles your fancy?...risk...reward....probabilty, in any combination you like!

Great brain exercise! (but I've got lactic acid build up, need to go do some warm down :D )

Cheers

[Magdoran]

Hello Margaret,


Thanks for the welcome. It is nice to find someone who is on your wavelength isn’t it?

Hmmm, it is a shame that the options are moving to $1 Increments for the higher priced stocks, most annoying really, but the percentages are still better than $5, wouldn’t you agree?

I certainly agree about the non directional and volatility plays being less effective over the past couple of years in the Australian market compared to straight positions on average. You still could have entered a lot of bull puts though, and done very well.

Butterflies work well in sideways market (hence more effective in the US), so I can understand you not using them in such a strongly trending/volatile market in Australia from 2003 onwards.

With the higher volatility now though, maybe it’s time for a few credit positions – I’ve been thinking about ratio spreads recently, but never tried them in practice.

As for theta, agree, not an issue for short term long options. But crucial for longer term plays, both credit and debit. Have a look at my comments to Wayne I will post below for some of my musings, and see what you think.


Once again thanks for the warm welcome.


Regards


Magdoran

[Magdoran]

Hello “Mr NEW Mexico” (Wayne),


I bet your family back home can’t understand you with a Geraldton accent!

Now, you raise a lot of valid points:

Low IV:
Implied volatility is usually lower in Australia, around 15-20, some times lower, sometimes higher – this is certainly an important criteria to factor in to decide to go long a call or put, so agree here.

Significant move:
Why I chose a significant move is because it highlights the effect of a finer gradation in strikes. Certainly entering an OTM long option requires a sufficient move to make a good profit (although you can still make 30-100%with a more common move as long as you don’t go too far OTM and ride the IV favourably).

The idea is to look for patterns where you are expecting an explosive move, and position accordingly to capture significant profits (partly to offset the times you get it wrong and do 30%, 50% or even 100% losses, plus the spread slippages and brokerage you correctly refer to). You have to get 3 elements reasonably right – time frame, magnitude, and direction.

Implied Volatility:
Yes, IV is key. If it is too high, this effects your strategy options, hence you start to consider either ignoring the opportunity, finding a different instrument, looking at credit spreads (like bull puts or bear calls for instance). But it also requires analysing the IV history, and projecting IV pretty much as you project stock movements, although the logic is different (as you know). I try to project what is likely to happen in tandem with the underlying, and especially how it will affect the chosen strategy. In fact, I have been known to spend more time working through the volatility scenarios than I did on the underlying chart.

Position Size:
Excellent point Wayne (MNM). You are right, you have to balance the position size with the risk, take into account the likely slippage and transaction costs, work out the probability of success, and look at the ramifications if you get it wrong (as well as if you get it right of course too).

When I trade this kind of high risk trade, I accept I may make significant losses (up to 100%). But if I can make higher returns from a sufficient number of successful trades, enough to counteract the costs and losses, I’m ahead. But this is still a work in progress, and far from a proven methodology – it will probably take me another 2-3 years to fully develop it. It is not for newbies, that’s for sure.

One point here is that the further OTM you go, the more time you should consider buying if long. You can play diagonal/calendar strategies here sometimes to help fund the position by selling at the same strike if conservative, or strike or two towards the money if more agressive in the current month (aiming to sell the most premium possible, usually with around 30 days to maximise theta decay in the sold position). Again not for newbies, but works nicely in an orderly trending underlying.

Contest Risk:
Can’t say I really understand this. I didn’t think the transaction costs were that great in the Australian market when the contract size is 10 times that in the states (1000 vs 100). This also has a marked advantage for the Australian market.

As for theta decay, the rules are straight forward. If long look to exit by the time the option is hitting 30 days (exception is to hang on when you bought OTM and it is deeply ITM – the theta decay and time value are often then a negligible component – one trick is to exit partial positions to lock in profit, say half, one third, or if conservative two thirds).

If short, try to sell with under 45 days time value and above 20 days if possible, also looking for IV skews in your favour.

Another trick in the book is to also enter a bull put or bear call at the same time as the single series long option – but only if you’re really sure it will either go sideways or in your direction, otherwise your exposure is much higher. The idea is that if your OTM position does nothing for a month, the credit spread helped to negate the theta decay, and finance holding onto the long option If still confident of a move (if not wind it out on the trading plan criteria – time, stop loss, profit stop, or partial /complete exit). The risk though is you get it really wrong, but at least your risk is limited in both cases.

Gamma:
Do you really use this a lot independently from all the other variables? I don’t, it just factors in with my model, so I know what things are likely to look like within a range, based on price action and time (includes forecasting IV too by the way). Gamma just helps to calculate how quickly the delta will change if your position moves in or out of the money, doesn’t it?

Significant moves in actuality:
Yes, if the underlying does move substantially in the direction you think it will, in the time you think it will, OTM positions really rake in the big profits, and this is really the challenge with this style of trading – time, direction, magnitude (and correct forecasting of IV).

What tickles my fancy???
Many things Wayne. I’m not a “satisfiser” by nature, but a “maximiser”. The ultimate objective is quite complex actually (funny, no one has asked me that for a long time), but in trading involves longer term targets, job satisfaction (I actually get a kick out of what I do), I like being able to recognise my errors and correct them (ala Soros), but it’s certainly nice to be right sometimes (which is probably universally true for everyone).

How about you?




Hope your lactic acid build up abated!


Regards


Magdoran

[wayneL]

Hope your lactic acid build up abated!

Remarkably, the body can use lactic acid for aerobic energy production. Unfortunately the brain runs exclusively on glycogen, so had to resort to a steady jog. (of course, the brain doesn't produce lactic acid anyway :p: )

***

Well what an interesting discussion! I don't think we've converted each other, but I don't think the goal was proselytization anyway. But certainly an appreciation of trading philosophy has been achieved.


Contest Risk:
Can’t say I really understand this. I didn’t think the transaction costs were that great in the Australian market when the contract size is 10 times that in the states (1000 vs 100). This also has a marked advantage for the Australian market.

Just for clarification, contest risk is the immediate cost of a simultaneous entry and exit of position i.e. (spread x 100(or 1000) x contracts) + (commish x2)

A larger position size to achieve adequate delta increases contest risk.

Commish: costs me $0.75 per contract.


What tickles my fancy???
Many things Wayne. I’m not a “satisfiser” by nature, but a “maximiser”. The ultimate objective is quite complex actually (funny, no one has asked me that for a long time), but in trading involves longer term targets, job satisfaction (I actually get a kick out of what I do), I like being able to recognise my errors and correct them (ala Soros), but it’s certainly nice to be right sometimes (which is probably universally true for everyone).

How about you?

Well... sticking strictly to trading matters....:D I broadly catagorize option trades as a punt or a book and therefore traders as either bookies or punters. (purely from a philosophical standpoint. This is not to infer that the punter is a gambler. This is just to reflect the risk/reward/probabilities preferences of a trader ) The bookie side of things is what tickles my fancy. But I will readily punt when the opportunity arises.

A bookie (and this time I'm refering to the trackside species) is, as a matter of survival, a punter as well. Books often should, or need, to be hedged with a punt. (Now speaking of the trackside AND the screenside bookie)

What part of Rome Revisited does your wife come from? Have you visited? What did you think?

Cheers

[wayneL]

Gamma:
Do you really use this a lot independently from all the other variables? I don’t, it just factors in with my model, so I know what things are likely to look like within a range, based on price action and time (includes forecasting IV too by the way). Gamma just helps to calculate how quickly the delta will change if your position moves in or out of the money, doesn’t it?


Mag,

Not really independantly with a directional trade, but a big factor in delta neutral trades as it is gamma that manufactures delta in this case.

When short gamma, obviously we want as little of it as practical and the plan is that theta will overcome any unwanted delta developed through gamma.

When delta neutral and long gamma, gamma is very much the prime consideration....well, and vega, but primarily gamma... because we want those deltas showing up asap.

The trading strategy known as "gamma scalping" where delta is continuously hedged thus locking in profits at regular and preferably very short intervals, indicates that gamma is the basis. But as with all strategies, the other greeks will always show up to play their own little role.

Very egotistical those greeks, they always want to have a say... just as bad as ex-yank option traders :D

Cheers

[Ageo]

When I trade this kind of high risk trade, I accept I may make significant losses (up to 100%). But if I can make higher returns from a sufficient number of successful trades, enough to counteract the costs and losses, I’m ahead. But this is still a work in progress, and far from a proven methodology – it will probably take me another 2-3 years to fully develop it. It is not for newbies, that’s for sure.

Regards


Magdoran


Hi Mag (great discussions btw),

i believe the above post is simply "positive expectancy"

Where your win/loss ratio might be less than 50% but your risk/reward is much higher. Knowing that you can achieve a higher risk/reward is so important and basically takes off the pain off being "right" and will allow you to take losses with a smile.

Remember positive expectancy should be based on worst case scenario which means your not always going to have a worst case scenario are you? :)

Like you said if you use OTM bought calls (as with puts) and the moves your after make over 500%+ . Then basically you can afford to lose 4 times (as long as your position size stays the same). To me thats a 25% win/loss ratio but a 5:1 ROR (return on risk) ratio

So even if your so bad at picking entries you will still have fantastic system. And remember the higher your win/loss ratio the small the ROR ratio has to be in order to be profitable.

But imagine having a win/loss ratio of 50% and a ROR of 5:1 ratio?

hehe now we are getting somewhere!

Adrian

[Magdoran]

Hello Wayne,


My wife grew up in Kansas, but lived in LA for a while. Yes, I’ve been there – love it! It is freaky though how a whole country can drive on the wrong side of the road! (hahaha – when in “New Rome”). But like Australia, it is a big country, and I’ve only see a fraction of it I’m sure. I could spend lots of time there and still not see all I want to. We’re looking to go over for thanksgiving later this year… looking forward to that.

As for conversion, that was never my intention. I kind of think about individual preferences for markets and instruments along the lines of a smorgasbord – I like chicken and you like beef, and the next person is vegetarian… (Or I LOVE Chocolate, and someone else likes lemon cheesecake – better stop this, I’m getting hungry!).

My purpose was to offer a different perspective for other readers to consider giving them more choices, and an insight into the experiences from those that have done it. It is also a good vehicle for discussing the way that the different “Greeks” effect risk and reward, and illustrates just how important it is to really do the ground work about how options behave, and to develop the capacity to project/forecast potential results using this kind of instrument.


Contest Risk:
Aha, contest risk, I kind of remember this term now – sure, the cost to immediately enter and exit is certainly a factor with way OTM positions, and certainly options with wide spreads, so this is why this strategy needs careful planning and use only when being able to project in time, price, and direction accurately enough to select the best risk/reward parameters.

This is only one of many approaches I use, and only in specific situations. It is a tool in the shed. But the process involved in considering this kind of trade really highlights the greeks, and shows the effect that different strike gradations can have in different markets (also shows how important IV is).

Now on this point of position size, actually you don’t increase the value (although you may trade more contracts in comparison). Interestingly, I tend to keep these positions fairly small (under 10 contracts Australian); hence the only additional cost is the OCH fee in and out.

Punter Vs Bookie:
Interesting “track” analogy. I suppose I’m a bit of both under your definition, but I’d like to think that I’m the “casino” Mark Douglas style, in that I’m employing a technical analysis and options edge… Ageo/Adrian’s comment is along these lines (kind of has elements of “positive expectancy”).

Gamma:
Delta neutral concepts at the advanced end get very hairy (which is why I set up a model and let the computer do all the hard sums). The problem I have is that implied volatility really messes things up, along with theta decay if short an option under 30 days (which is often a primary focus of a market neutral credit spread). Sure, with things like butterflies and condors, and perhaps in ratio spreads (especially in different time frames) this is a consideration, but I still hold IV is key here, and theta decay.

I never did really get into gamma type trades, (just didn’t see this style as attractive as other approaches in this kind of market), but I’d be interested if there is a gamma player out there who’d like to share their knowledge (this is not a strong suit of mine, trading this way). Could be interesting… (We could also talk IV though; I think this is really relevant in all trades).

I found McMilan’s book “Options as a Strategic Investment” to be invaluable for this kind of options theory... ever get to read it?


Regards


Magdoran

[wayneL]

We’re looking to go over for thanksgiving later this year… looking forward to that.

Have fun! But beware of constitution free zones (airports, and increasingly, everywhere else)


As for conversion, that was never my intention. I kind of think about individual preferences for markets and instruments along the lines of a smorgasbord – I like chicken and you like beef, and the next person is vegetarian… (Or I LOVE Chocolate, and someone else likes lemon cheesecake – better stop this, I’m getting hungry!).

My purpose was to offer a different perspective for other readers to consider giving them more choices, and an insight into the experiences from those that have done it. It is also a good vehicle for discussing the way that the different “Greeks” effect risk and reward, and illustrates just how important it is to really do the ground work about how options behave, and to develop the capacity to project/forecast potential results using this kind of instrument.


.....but I don't think the goal was proselytization anyway. But certainly an appreciation of trading philosophy has been achieved.


;)



Gamma:
Delta neutral concepts at the advanced end get very hairy (which is why I set up a model and let the computer do all the hard sums). The problem I have is that implied volatility really messes things up, along with theta decay if short an option under 30 days (which is often a primary focus of a market neutral credit spread). Sure, with things like butterflies and condors, and perhaps in ratio spreads (especially in different time frames) this is a consideration, but I still hold IV is key here, and theta decay.

Indeed, IV is most certainly the key. The first point of analysis for me. This will immediately narrow down the selection of strategies I will employ in any given situation. This is where a lot of traders get into trouble. One must have a precise view of market direction (even if it is precisely imprecise). But then one must have a view of volatility within the term of the option. When all the planets line up, there is very high probability of profit.


I never did really get into gamma type trades, (just didn’t see this style as attractive as other approaches in this kind of market), but I’d be interested if there is a gamma player out there who’d like to share their knowledge (this is not a strong suit of mine, trading this way). Could be interesting… (We could also talk IV though; I think this is really relevant in all trades).

I don't think the technique is useable in the Aussie market, not in a gamma scalping context. I think gamma/VEGA delta neutral trades have possibilities. I posted a paper trade along these lines on OSH somewhere on this board that turned out quite good.

In the US Gamma scalping is a great technique. But as mentioned above, all the planets have to line up. It can't be applied indiscriminantly (as with any trade) But when the right conditions turn up, I'm in. They work VERY well.


I found McMilan’s book “Options as a Strategic Investment” to be invaluable for this kind of options theory... ever get to read it?

Almost unbelievably, I have never read it. Haven't read Natenbergs book either. I learned mostly from Charles Cottle. By an incredible stroke of good fortune, I ended up in an IRC chatroom with him and able to ask questions directly.

The guy is a savant and incredibly generous with his knowledge (it was a free , public chatroom), and while the process did involve several episodes of brain fission, I did manage to pick up lots of stuff... enough to be able to put the missing pieces of the jigsaw puzzle together myself. (Saved all the transripts :D ) I spend most of my time with modelling software and observing greeks real time (Ironically I used to enjoy observing certain types of Greeks:girl: while sitting in Melbourne cafe's before I started trading options :D )

McMillans book is on the to-read list, as is Natenbergs.

They are both highly regarded enough by people I respect for me to suggest them as must reads for any aspiring options trader.

Cheers

[Magdoran]

Hi Wayne,


Natenberg and McMilan are both on my shelf, and I refer to them from time to time. I don't lend these out - but I do let the Guy Bower book out for newer to intermediate options players...

All well worth reading.


Magdoran

[wayneL]

At some stage I must aquire the aforementioned tomes. Better read what I've been suggesting people read huh?

I've got a couple of Cottles books, which have served as my options bibles.

I've also got a really interesting book - "Trading Options To Win" by Stuart Johnston. This guy thinks out of the square, and is at times, absolutely hilarious... he trades commodity options, and is into statistics, seasonals etc., not one price chart in the whole book. But of great interest even to a techie.

Cheers

[sails]

Hello Margaret,

Thanks for the welcome. It is nice to find someone who is on your wavelength isn’t it?

Hmmm, it is a shame that the options are moving to $1 Increments for the higher priced stocks, most annoying really, but the percentages are still better than $5, wouldn’t you agree?

I certainly agree about the non directional and volatility plays being less effective over the past couple of years in the Australian market compared to straight positions on average. You still could have entered a lot of bull puts though, and done very well.

Butterflies work well in sideways market (hence more effective in the US), so I can understand you not using them in such a strongly trending/volatile market in Australia from 2003 onwards.

With the higher volatility now though, maybe it’s time for a few credit positions – I’ve been thinking about ratio spreads recently, but never tried them in practice.

As for theta, agree, not an issue for short term long options. But crucial for longer term plays, both credit and debit. Have a look at my comments to Wayne I will post below for some of my musings, and see what you think.

Once again thanks for the warm welcome.

Regards

Magdoran

Hi Magdoran,

Yes, it is a shame about the strike prices - but seems like that's what we've got to work with now. The retail options trader doesn't seem to get much consideration from the ASX in spite of the fees they happily collect from us!

I have traded quite of lot of bull call spreads (in preference to their bull put counterpart - same strikes) mainly due to the fact they are easier of manage if they go wrong. But the thing I don't like about spreads in general is capping potential profits. They don’t allow for profits to run on a good move. All too often I've seen the short call increasing almost as fast as the lower long call (probably due to volatility smile) only to find the target has been reached in the underlying and practically no profit in the spread. After all, a spread may only have max profit of 10-20c and may have to wait closer to expiry to be achieved, so it’s almost easier to pick this up on a directional move with long premium. However, I’m careful with position sizing as it’s possible to lose the lot especially with overnight gaps we see so frequently in the Aus market. But then, also easy to lose on a spread too – just different greeks doing the damage.

One thing I really like with being long an OTM is if the trade goes the wrong way, delta slows down, however if I'm right, gamma increases and accelerates delta in my favour. The trade-off's here are theta risk and possibly some fall in IV. But as I mentioned before, I'm only in for such a short time that theta is not an issue and being either front month or close to it, the position is not so badly affected by IV changes.

The closer I am to expiry, the closer the OTM strike needs to be. I have been surprised at how well Aus options hold their value even fairly close to expiry. Perhaps there are a lot of sellers out there closing short premium positions.

I’m being a lot more selective at the moment with IV’s running at higher levels, but generally still find the short term trades work OK provided I can find those quick moves together with selecting a suitable strike – and that’s where knowledge of the greeks is a necessity.

Wouldn’t recommend anyone trying this without thorough testing as it’s too easy to lose money with long premium if the position is not actively managed. It’s not a “set and forget” strategy. Also, the way I use it is based on my interpretation of TA and targets, option greeks and probably some intuition thrown into the mix. Of course, not every trade is a winner, so money management is still vitally important for overall success. And like you, this is still a work in progress and still making improvements. But then, I think option trading is always a work in progress!

I did have some success with butterflies on newscorp a couple of years ago – yes it was sideways with quite high IV. I also found the max pain theory worked quite well at the time. But when Murdoch decided to take his company to the US this affected liquidity a bit and IV levels came down. I trialled max pain on other shares, but for some reason they do not seem to pin to the max pain strike with any regularity.

I'm interested in the diagonals you mentioned earlier – sounds like a calendar bear call spread? Have you been trading these for a while and have you had any consistent success with them?

I’ve read a bit about ratioed diagonals on another forum recently and they look quite interesting. Low IV would be essential with more longs in a back month. Looks like directional risk shifts to IV risk with this type of ratio spread so would not be so good in our current IV situation at the moment.

Cheers,
Margaret.

[Magdoran]

Hello Margaret,


Sounds like we’re on the same page for a lot of options approaches you’ve covered.

I certainly agree you really need to consider how far OTM to go. The usual rule of thumb I use is to set a target time you expect a movement to happen, and add to it (say 14 days or more), and buy with enough time to ensure there is still at least 30 days to expiry past the most conservative/worst case time projection, this way you can avoid a lot of theta decay. This has to be balanced though with the raw exposure to strong adverse movements, and spread risk exiting when the market makers hit you exiting on weakness/stop.

You are quite right about the delta reducing as an OTM option moves further out of the money. This is an advantage and helps to reduce risk, although the spread in lower volume traded options is the real danger.

Interestingly, I think that you can actually do quite well on longer dated trades in a strongly trending market. My shorter term trades are either counter trend plays, or playing blow off moves after a confirmed breakout – but this is highly T/A oriented.

The counter trend plays I have executed are quite risky - like buying puts against a strong bull market. I’ve done a lot of these successfully taking advantage of the low IV for entry, and the IV rush on exit for fast moves down – you really have to take profits to work these effectively I have found (say half at key prices, exiting on strength), and gingerly winding them out since there is so much upside risk when adverse T/A indicates a good chance of a bullish resumption.

Bull Call spreads:
I have found these are pretty lame in most market conditions, and discarded using them a while ago. When I did these initially, so many times my T/A target would be reached, and like you, the IV would kick up in the sold position, either negating most of the profit, or sometimes resulting in a loss.

The core idea of the Bull Call spread (and Bear Put) is to limit risk through selling a higher strike, but I found you really had to watch the IV since the further OTM call often had a lower IV, which characteristically increased while ATM or more so ITM. They were really designed for mildly bullish markets to avoid theta decay and exposure.

I found that trading these in the US was suicide. I don’t know how many of these I tried (I think about 10 overall) unsuccessfully around 2003-4 for a variety of reasons – adverse IV skews (sold call appreciating more in IV than the bought one), unable to exit either on profit or on stop (since the exit order was often 5 cents short of transacting while I slept since my IV calculations were sometimes fractionally out, or the US market moved against me so violently even the spread couldn’t reduce the loss).

I remember getting my T/A projections spot on with one bull call spread, but I never got to exit it for about 3 nights in a row, until I stayed up one night to force it to fill because of adverse skews, and my orders not filling. By this time I went from a potential 100%+ gain to a substantial loss.

I quickly learned that single option positions were much more effective, especially in strongly trending markets, and that uncapped profits from OTM single series positions greatly outperformed the capped/brokerage riddled Bull Call/Bear Put spreads.

Key disadvantages/dangers are:
• Brokerage: 4 legs – 2 to open, 2 to close
• Adverse IV skews against your position
• Difficulty winding out the position
• Capped profits
• Unfavourable theta decay

Bull Put spreads and Bear Call spreads:
I found that Bull Put spreads and Bear Call spreads are generally much more effective than Bull call/bear put spreads because you only need the market to go sideways or mildly in your favoured direction to make reasonable profits. If you’re lucky you can just let the spread expire worthless and avoid the 2 extra legs in brokerage when the sold strike is OTM at expiry.

Also, you tend to be selling better IV returns ATM or slightly ITM to the OTM bought position on average. For example, theoretically the idea is to aim for a 1:1 Ratio for maximum risk to maximum reward. You can sometimes get 30-40 cents premium for a 50 cent spread if you’re lucky in the day when volatile movements are occurring in the Australian market, and it skews in your favour, leaving only 10-20 cent exposure for the maximum risk.

Theta decay usually works in your favour, especially with ATM/slightly ITM strikes sold with around 25-40 days time value (aiming for 30) – the theta decay over 14 days is usually profitable if you have to wind out the spread on technicals, and if you can hold for longer, the last few days to expiry are vicious on the sold position’s value. I think this is a huge advantage over Bull Call spreads, especially in a higher volatility environment.

But, just like any of these kind of positions, they need to be managed, and wound out either in profit or at a protective stop – I don’t agree you just set them and forget them (although if your T/A’s any good you can sort of do this when there are good moves in your favour in your timeframe).

Key advantages are:
• IV skews tend to be in your favour
• Capped loss
• Favourable theta decay
• Sideways/ favourable movement usually ends up profitable
• Can sometimes let the spread expire worthless for maximum reward

Diagonal Spreads:
These are fun. You are right Margaret, these are combinations of calendar spreads with bear call/bull put elements, but the idea is you want to buy an OTM position, and finance it on the way up/down (usually up since downward moves are usually faster if strong).

The idea is to sell closer to the money for the current/front month if you’re very confident it will expire worthless on a mildly trending underlying. Sell at the same strike if there is some risk of the sold strike expiring ITM. Sell away from the bought strike (if there’s sufficient premium – often not worth doing) when there is a real risk of a move too fast putting the sold position well in ITM at expiry.

The use of ratios gets a bit complex, but you can use ratios of 2:1, 3:2, 5:3 for instance. This could be 5 bought and 3 sold for instance, or the other way around (but quite risky since there is an unlimited risk component involved – but usually good premium if you set it up right), with sold positions in the current month, at the same strike, close to the money, or further away – whatever corresponds to your T/A target, and your skew/hedging objective. These can be morphed too by buying back positions, or selling, or both… this is a whole area of finesse though, and needs more than this cursory description.

The diagonals that work the best tend to be in a mildly trending market, and when there is sufficient premium to sell with 30 days time left, usually not too far from the money, but not too close to it. If worried by the prospect of ITM expiry, you could consider making the position a ratio back spread by selling less contracts than the bought position, but the rules I’ve developed for this are quite involved, and very dependent on my T/A projections.

Fully agree that this is the time to be selective right now – a very volatile and hard to read market – for the shorter term. As for butterflies, I’ve never done one, considered it, and modelled it for other people, but just don’t like the high brokerage, and the limited reward, especially when there’s better pickings to be had, but may use these in a sideways market if it eventuates.

Wow, that’s a lot of page space above, and I still haven’t covered half of what I set out to say… But I’m happy to go into more detail at some point in the future, but I hope this illustrates some of the points you were looking for me to cover.


Regards



Magdoran

Terms:
OTM = Out of the Money
ATM = At the Money
ITM = In the Money
ROI = Return on Investment
T/A Technical Analysis
Skew – where the volatility level/effect is different between different strikes in time or price, or both – where the natural readjustment of this can be advantageous or disadvantageous.

[wayneL]

Hey Guys/Gals,

Just a couple of comments

Sound like you guys are basically swing trading with options. You are buying delta with the view of exiting the entire position within a set, short time frame. I agree that straight option buys are the way to go here. Fugget diagonals (as you've discovered). Although they will reduce the purchase price of the bought call, it's not a lot... not worth the profit potential forgone. Plus contest risk doubles (not just commish, but buy/sell spread as well).

I am however puzzled as to the specific problems, re IV skews between the the bought and sold strikes. Although it does occur, I never experienced it to the extent you guys have. I would consider that an anomoly. Mag you were just unlucky... what sort of stocks were you playing?

Verticals should be used if one intends staying with the position and morphing as you go along. As a bread and butter strategy, they are second to none. But it's not a swing trade strategy. They are more a "part" of a string of strategies one can use as ones view changes, setting up advantage. They also have great use in adjusting deta neutral strategies... moving the goal posts so too speak.


http://vw-organics.netfirms.com/options_metamorhosis.jpg

Of course this is a different philosophy of trading options.

Re Diagonal spreads

An excellent strategy. But what is a diagonal spread? It's a vertical spread with options of different expiry dates. Not that different is it? They do expose you to more downside risk in the short term, and also, as Margaret pointed out, potential vega risk as the longer dated options will be more vega sensitive. So caution with IV levels there. The flip side of that is we can benefit from vega if we buy low IV.

Folk who like CC's would do well to consider this strategy, particularly using LEAPS (Do you have those in OZ?){Leaps are bsically options with expiry dates > 9 months, up to 3 years...maybe long term warrants could be a substitute if not}

In many ways these have a lot of advantages over bull put spreads (the latest miracle strategy :banghead: ) if the intention is to use as a stand alone strategy. A slight ratio will correct the tendency to drop a bit of profit the further away from the sold strike you go... I presume thats why you would do that Mag.

Butterflies:

...rock on indecies (not XJO :p: ). Well I prefer condors (just a stretched out butterfly) This has been my bread and butter trade for a while now. (Legging in with writes and/or credit spreads and adjusting if necessary with verticals) Why? because indicies suffere from chronic overvaluation. It's a tidy little edge and margins on written futures options, because of the SPAN system, are very sensible. Got a thread on this somewhere.

Gawd we option traders can waffle.. thats enough, I'm off for a beer.

Cheers

PS Whats the very best strategy?

All of 'em.

[Magdoran]

Hello Adrian/Ageo,


I’m glad you like the discussions so far, and hope they are useful.

Now, I have been meaning to address the points you made earlier, since in a related way they are relevant to option trading.

As for “positive expectancy”, I actually think this is quite an involved topic (probably not suited to this thread), which is bandied about by all sorts of people, many with entirely different definitions (some talk about Van Tharp’s definition, and others seem to put their own spin on this subject).

Firstly, let me make a quick observation about this area – I agree on the whole with Wayne’s comments on other threads about discretionary trading vs mechanical trading. I really think it is up to the individual how they trade, and as Wayne quite rightly states, there are many ways to skin a cat – certainly in this kind of market – the trick is to find your niche, isn’t it?

I’m firmly in the “intuitive” camp, and believe that while you can learn a lot from studying charts and other forms of financial/economic history (and I do think this is very worthwhile), that (ala Mark Douglas) “every moment in the market is unique”, and that “anything can happen”.

My belief (and I really challenge the questionable notion that anything can be proven to be true absolutely, or even subjectively in many cases – I have a real issue with determinism and the idea of inevitability) is that investments are inherently unstable and can fluctuate in value wildly; hence traders need to be flexible in their approach. What was true yesterday may be totally untrue today. Some mechanical adherents argue that you should develop a rigid system based on endless “back testing”, and that this will give you a casino like edge following a systematic formula.

I don’t agree with rigidity in thinking – sure, having a fixed view works for a limited period... and then it doesn’t. I would argue that it is important to maintain a vigilant mind always feeling forward from the brink, aware that change could be just around the corner, and that a rigid system constrains the flexibility to both avoid unfavourable developments and take the appropriate action, and also to not properly orient oneself to take advantage of opportunities.

I subscribe to George Soros’ “Reflexivity” concepts, and follow his approach to “dynamic disequilibrium” (see Soros on Soros – which explains many of his theories in “The Alchemy of Finance”). The key is to look for a divergence in reality from market perception, and take advantage of it decisively. Staying out when conditions are not right makes a lot of sense to me, then striking hard when an opportunity presents itself, rather than plodding along with a stayed old system, and neglecting the big opportunities in the future.


What I’m saying here is that you can choose a Buffet style, or a Soros style, or even your own, and be successful or fail… it’s really up to the individual. So as for my approach, it is constantly changing (hopefully in line with the market), and I believe most of the really successful players are the same. They never stand still, do they?


Regards


Magdoran

[hissho]

HI Wayne


Butterflies:
...rock on indecies (not XJO :p: ). Well I prefer condors (just a stretched out butterfly) This has been my bread and butter trade for a while now.


Why's that? why not XJO?

thanks
hissho

[wayneL]

HI Wayne


Why's that? why not XJO?

thanks
hissho

Condors are best in choppy, basically sideways markets, and the XJO has been trending strongly. You can shift the goal posts as you go along, but unless you want to get really agressive, this will reduce profitability. If you keep having to move the goalposts, risk reward starts looking a bit dodgy.

We don't want a trend.

Cheers

[Magdoran]

Hello Wayne,


I trade all kinds of strategies. I basically trim my sails to the wind – adapt the most appropriate risk/reward strategy to the situation. Most people have a preference, and mine is certainly directional, and really like to pick up nice capitulation/blow off moves if they’re around.

But my comments were aimed to address Margaret’s post, hence the focus on directional trades. I note you like the non directional side of options trading, and certainly a lot of people do this very successfully in the states.

I’m perfectly happy hedging longer term positions, or adopting sideways or volatility strategies when appropriate. But when you have such a strongly trending market in Australia, why wouldn’t you trade directionally? (How often do sideways strategies make over 1000% ROI in under a month???).

Spreads:
Regarding my experience with Bull Call spreads - the IV skews were one key element, and if you try these, it is a problem if the bought call is closer to the money and the IV is higher, but that’s just one component… the other is winding out a spread when you’re not wanting to stay up all night. Perhaps I was unlucky, but why then did my OTM calls and bull puts make good returns when the bull calls didn’t?

The profit movement in Bull Call spreads is lousy compared with OTM calls – you might just have well bought one strike OTM for a short move and taken the unlimited reward from the OTM call for a sustained greater magnitude movement (or tried going ATM or even slightly ITM). The other thing I found was that bull put spreads really outperform bull calls. Try replaying different conditions using the actual mid price for the spread, and see which yields the better risk to reward profile. My money is on the OTM call (literally) and also bull puts/bear calls. Most of the stocks I was trading were Dow, some NASDAQ and S&P 500 constituents in answer to your question.

LEPO’s
Regarding the Australian market and long term options like the US LEAPS, check out the ASX site for details on LEPO’s – “Low exercise Price Option”, which have about 1 year to maturity, and involve a kind of margin element. They are described as being a forward purchase of shares where you don’t pay the full premium up front, they are European exercise, only calls are available, and there are ongoing margin payments for both buyers and sellers. Interestingly they have a very high delta and move closely in line with the underlying. I’ve never traded these…

Ratio positions:
Re ratio usage – this is quite a detailed area, and probably needs a whole examination on its own at some stage, but the idea is to look to reduce initial outlays while increasing potential rewards for the back spreads, and look at locking in credits for ratio positions, with a chance of making good returns, but also risking unlimited exposure if a catastrophic move happens in the wrong direction.

The use of a ratio for OTM calls for instance is to help to finance the position/generate revenue on the way up, and also to reduce exposure if a major move happens against the position, but without sacrificing the unlimited reward aspect through the use of a ratio back spread approach if a major move occurs in the longer term projected direction, but occurs before the sold positions expiry date.


I hope this answers your questions… and yes, we options buffs can really ramble on, can't we?


Regards,


Magdoran

[wayneL]

But when you have such a strongly trending market in Australia, why wouldn’t you trade directionally? (How often do sideways strategies make over 1000% ROI in under a month???).

Indeed! Not withstanding, ROI is only part of the equation.



Regarding my experience with Bull Call spreads - the IV skews were one key element, and if you try these, it is a problem if the bought call is closer to the money and the IV is higher, but that’s just one component… the other is winding out a spread when you’re not wanting to stay up all night. Perhaps I was unlucky, but why then did my OTM calls and bull puts make good returns when the bull calls didn’t?

It's got me stumped. Without knowing the specific stock strikes expiries etc etc I wouldn't even hazard a guess. I've put on hundreds of these and never experienced that..at least not to that extent.

What genarally was time till expiry, distance between strikes etc IV's etc?


… and yes, we options buffs can really ramble on, can't we?


I remember looking at option traders threads before I was into them. Verbose jargonistic twaddle I thought. What have I become? :eek:

:p: Cheers

[Magdoran]

Hello Wayne,


Yes, it is scary how much jargon creeps in, isn’t it… and after a while you start to lose your objectivity don’t you? I can really appreciate what it must be like to be a newer player, and have to wade through a torrent of stuff you don’t understand (yet!).

I hope we don’t scare everyone away, so please, if any newer players have any questions, please ask away. And please don’t feel intimidated, this is a really complex area, and if you don’t ask the silly questions, I can assure you, it’s unlikely you will get to ask the hard ones…

Re the Bull call spreads, just go back and see if you could have done better with OTM calls and bear puts, and compare the risk and reward. The conclusion I came to is to ditch the bull calls – but that’s just me.

Regards,


Magdoran

[wayneL]

[verbose jargon]



Re the Bull call spreads, just go back and see if you could have done better with OTM calls and bear puts, and compare the risk and reward. The conclusion I came to is to ditch the bull calls – but that’s just me.

For me it depends entirely on my view of price movement and volatility.

OTM short verticals (if left till expiry and no defensive tactics are used) have an inherently poorer risk reward ratio than a long ATM vertical. However they have a higher probability of success. Basic stuff here.

OTM short verticals are more about where the stock won't go(much the same philiosophy as a short put {or synthetic short put AKA Covered Call}) and realated strategies, rather than a speculative directional play. On the other hand ATM verticals have more speculative potential (but not as much as a straight long option).

More importantly from the standpoint of the morph player, ATM verticals have far more defensive and metamorphosis potential. The OTM vertical is a pig to play with in that respect.

In that sense IMO ATM vertical have WAY more risk/reward/probability potentail in the speculative, directional picking, dynamical hedging sense. Also not forgeting that the ATM vertical can be legged into from a long ATM or ITM options. (not practical in most cases from an option entered into when a fair way OTM)

In this way and if things go to plan, a trader work themselves into better than risk free situations, sweeping cash into our account as we go along.

However, I'm not averse to the OTM vertical in the slightest, for what is a condor, but two OTM short verticals (the iron version of anyway)? Along with chronic overvaluation, This is manna from heaven for the premium seller.

Thinking about the ATM vertical problem, I would sure be interested in the time til expiry and IV levels of the spreads you were putting on. This, along with the width of strikes can have a dramatic effect when IV levels start bouncing around. One of the key measurements here is position delta. This tells volumes.

[/verbose jargon]


I hope we don’t scare everyone away, so please, if any newer players have any questions, please ask away. And please don’t feel intimidated, this is a really complex area, and if you don’t ask the silly questions, I can assure you, it’s unlikely you will get to ask the hard ones…

Ditto that.

Cheers

Image from CWS by Charles Cottle \/

[RichKid]

At some stage I must aquire the aforementioned tomes. Better read what I've been suggesting people read huh?

I've got a couple of Cottles books, which have served as my options bibles.

I've also got a really interesting book - "Trading Options To Win" by Stuart Johnston. This guy thinks out of the square, and is at times, absolutely hilarious... he trades commodity options, and is into statistics, seasonals etc., not one price chart in the whole book. But of great interest even to a techie.

Cheers

Hi Wayne,
What are those Cottle books? This is the link to the three books I found on Amazon by Cottle, I assume these are the ones ($300 for one of em- sheez!! (latest one at the top). http://www.amazon.com/gp/search/104-1098788-9571936?search-alias=aps&keywords=cottle%20options

I note that Coulda Woulda Shoulda was on your site- identical to the original? I also saw a new title by him which had come out earlier this year- Options Trading: The Hidden Reality. The latest one appears to be a collection of the previous material (with beautiful 'living' colour) and additions:


This new book is an expanded revision of "Options: Perception and Deception" and "Coulda Woulda Shoulda". O:PD was published by McGraw Hill in Hardback and I obtained the rights back to self publish the derivative CWS to give away at my brokerage firm from 2001 to 2003. Because they are out of print, O:PD sells from between $299 and $399 while CWS fetches between $55 and $125 where rare books are sold. "Options Trading: The Hidden Reality" not only printed in color has 100 more pages and features more dissection illustrations on popular wingspread (stretched-out condors, slingshots and skip-strike-flies) and calendarized spread (double diagonals, straddle strangle swaps and double calendars) configurations. I think what made O:PD in such demand were the 3D graphics and the Skew Library. They are both brought back in color along with the appendix proving Chapter 2's Options Metamorphosis.

[Magdoran]

Hello Wayne,


Re Bull Call spreads:
Going back through my notes on Bull Call spreads back in 2003-4, these were mid term trades of about a month projected duration. The problems I identified was using strikes too close together, problems with winding out positions using contingent orders when the IV skewed against my positions, sudden adverse movements, and contingent stop loss orders not getting filled (since the gap against my position was so strong).

(The width of the strikes is important, and I’d agree you need to ensure the width is not too narrow or too wide…).

I was buying bull call spreads with around 65-90 days time value, with a 30 day trading horizon, and incorporated time stops at 30 days till expiry. IV was mixed: some high, some mid range… but none were really low (compared to Australia at the time anyway).

Oddly, all my Australian plays were successful at the time using bull call spreads, but on revision, straight calls/puts and bull puts/bear calls would have yielded better returns, and similar risk. Now this is interesting because I think I never had a successful bull call spread work in the US, but did OK in Australia, what does that tell you? Also interestingly, I had several successful OTM straight calls combined with bull puts in the US at the same time too…

Another element was my T/A was different at the time, and not as time/price accurate as now, and on a couple of occasions bought/sold false breaks – but this was then a T/A problem, not an options performance issue.

So there you have it Wayne…

So, what is your approach/experience? Time frame, strike width, market area, do you stay up to enter/exit? Do you think the risk/reward characteristics of bull call spreads/bear put spreads are better than other alternative options strategies? In essence what are the conditions you look for to select the appropriate strategy?


Regards


Magdoran
P.S. Love the diagrams!

[Magdoran]

Hello Wayne,


I’ve been meaning to comment on your chat with Cottle. That was amazing actually getting to talk with Cottle online, what a scoop!

It’s great that you’re relating your experiences here, and I’m sure everyone will find the text recommendations useful. I must go and have a look at some of your recommendations too sometime...

I tend to relate to RichKid’s comment about the price though (but if it’s really good, it’s just an investment, isn’t it? – Just as long as the “investments” don’t outweigh the returns huh? Hahaha).

But this is what the forum's all about isn’t it? Sharing ideas, and developing…


Regards


Magdoran

[wayneL]

Hi Wayne,
What are those Cottle books? This is the link to the three books I found on Amazon by Cottle, I assume these are the ones ($300 for one of em- sheez!! (latest one at the top). http://www.amazon.com/gp/search/104-1098788-9571936?search-alias=aps&keywords=cottle%20options

I note that Coulda Woulda Shoulda was on your site- identical to the original? I also saw a new title by him which had come out earlier this year- Options Trading: The Hidden Reality. The latest one appears to be a collection of the previous material (with beautiful 'living' colour) and additions:

Yep they're the ones Rich,

I've got "perception and deception" (didn't think it was still available) and of course, "coulda woulda shoulda".

Pass on perception and deception. It's more for the professional MM, it'll definately cause brain fission LOL.

CWS is the best for us mug punters. But it's still fairly advanced and pretty much jumps straight into the deep end. Can cause spontaneous combustion of any flammable material within 1.5 mters of your brain.

Haven't got the new one yet. Letting my brain degrade a few half lives first :D

[wayneL]

Hello Wayne,


Re Bull Call spreads:
Going back through my notes on Bull Call spreads back in 2003-4, these were mid term trades of about a month projected duration. The problems I identified was using strikes too close together, problems with winding out positions using contingent orders when the IV skewed against my positions, sudden adverse movements, and contingent stop loss orders not getting filled (since the gap against my position was so strong).

(The width of the strikes is important, and I’d agree you need to ensure the width is not too narrow or too wide…).

I was buying bull call spreads with around 65-90 days time value, with a 30 day trading horizon, and incorporated time stops at 30 days till expiry. IV was mixed: some high, some mid range… but none were really low (compared to Australia at the time anyway).

Oddly, all my Australian plays were successful at the time using bull call spreads, but on revision, straight calls/puts and bull puts/bear calls would have yielded better returns, and similar risk. Now this is interesting because I think I never had a successful bull call spread work in the US, but did OK in Australia, what does that tell you? Also interestingly, I had several successful OTM straight calls combined with bull puts in the US at the same time too…

Another element was my T/A was different at the time, and not as time/price accurate as now, and on a couple of occasions bought/sold false breaks – but this was then a T/A problem, not an options performance issue.

So there you have it Wayne…

So, what is your approach/experience? Time frame, strike width, market area, do you stay up to enter/exit? Do you think the risk/reward characteristics of bull call spreads/bear put spreads are better than other alternative options strategies? In essence what are the conditions you look for to select the appropriate strategy?


Regards


Magdoran
P.S. Love the diagrams!

Hi Mag,

I see a few areas where I do things differently.

1/ Width of strike (as you've already mentioned) If too close together you have to increase the number of contracts do develop any sort of position delta... and the longer til expiry and the higher the IV, the more marked this becomes. Presuming we are on the positive side of the break even point... The longer dated vertical leaves you more suseptable to being short vega, without enough positive theta to develop some profit. The number of contracts also increases contest risk to unacceptable levels... 4 lots of commish plus 2 lots of spread, on a large number of contracts = ouch.

2/ The time stop. Again presuming we're on the right dide of the BEP. By exiting 30 days before expiry, you are not putting to use all that positive theta in the final 30 days. If possible you want the spread to expire, and let assignemnt/execise take you out... cheaper. Any pin risk can be dealt with if necessary.

3/ Using stop losses/contingency orders. MM's just love them, They know where people like to stop out and will widen the spread.. it's just giving them money. It's much better to morph than stop out. One of my most memorable trades was a long call, morphed to an ATM vertical, morphed into a synthetic put backspread on EBAY. Made a fortune on it.

Just my thoughts.


...later

[wayneL]

So, what is your approach/experience? Time frame, strike width, market area, do you stay up to enter/exit? Do you think the risk/reward characteristics of bull call spreads/bear put spreads are better than other alternative options strategies? In essence what are the conditions you look for to select the appropriate strategy?


Regards


Magdoran
P.S. Love the diagrams!

Every situation is different. One way of looking at option trading, is selecting a strategy, and finding stocks to use it on

The other way is to find a stock you want to trade, and select strategies according to your view of it's movement/non-movement and IV levels (both relative and absolute).

I fall into the second group. I'm not looking to put on an ATM vertical per se', only if I think it's the best strategy at the time. Depending on how much of a smart-@rse I'm feeling, I may even leg in to the strategy I thinking of..

Every situation is different.


I’ve been meaning to comment on your chat with Cottle. That was amazing actually getting to talk with Cottle online, what a scoop!

Truly, it was an absolute fluke. This one guy had offered to teach us some stuff about options and made a time every week to do it (all for free... just to help out) His knowledge was good but he was very nervous and had a problem with delivery...stage fright basically.

His "associate" takes over to get this guy out of trouble... it was one Mr. C. Cottle. At the time I had no idea of the significance of what was happening, but he did it for several weeks. A very generous guy... very cool!

The first guy was no dumb@rse either and was terrific with text-only chat.

Cheers

[RichKid]

Yep they're the ones Rich,

I've got "perception and deception" (didn't think it was still available) and of course, "coulda woulda shoulda".

Pass on perception and deception. It's more for the professional MM, it'll definately cause brain fission LOL.

CWS is the best for us mug punters. But it's still fairly advanced and pretty much jumps straight into the deep end. Can cause spontaneous combustion of any flammable material within 1.5 mters of your brain.

Haven't got the new one yet. Letting my brain degrade a few half lives first :D

Thanks Wayne, glad CWS is a bit hard too in your view as I couldn't really understand it at first blush. What little is left of my mind must be protected from people like Cottle so thanks for the warning, maybe the cover should have one of those radiation warning signs, red and yellow with a big exclamation mark, skull and crossbones etc.....

Is 'Options as a Strategic Investment' similar to Cottle in terms of depth or does it have additional material which will help in other fields of trading? Although I rarely trade options I find the concepts and observations re price have helped my in my general trading, especially the volatility studies.

[wayneL]

Thanks Wayne, glad CWS is a bit hard too in your view as I couldn't really understand it at first blush. What little is left of my mind must be protected from people like Cottle so thanks for the warning, maybe the cover should have one of those radiation warning signs, red and yellow with a big exclamation mark, skull and crossbones etc.....

LOL Perhaps we should lobby parliament for this. Everything else has to have a doggone warning these days. :sly:


Is 'Options as a Strategic Investment' similar to Cottle in terms of depth or does it have additional material which will help in other fields of trading? Although I rarely trade options I find the concepts and observations re price have helped my in my general trading, especially the volatility studies.

As I say I have never read it. At ~1,000 pages it must be pretty comprehensive, but allegedly is a comparitively, much easier read.

Cheers

[RichKid]

LOL Perhaps we should lobby parliament for this. Everything else has to have a doggone warning these days. :sly:

lol, Yes, very true! I still can't believe how easy it is to open an options trading account, I'd encourage people to sue if they make losses, you should see how simple the comsec forms and questionnaires are.


As I say I have never read it. At ~1,000 pages it must be pretty comprehensive, but allegedly is a comparitively, much easier read.
Cheers

Oops, sorry Wayne, I should be asking Magdoran the question.

So do you think Johnston's suitable for beginners Magdoran? I've had a look at Natenberg and the statistical stuff in it is easier to undertand, has some diagrames too. btw, welcome to ASF! Sorry for not chatting earlier, didn't want to butt in on the high level discussions! ;)

Rich

[Magdoran]

Hello Richkid,


Thank-you for the warm welcome, and please don’t be put off by Wayne and I rabbiting on about options – it’s just nice to have a shared passion as I’m sure you’ll understand. I suspect I may have had a hand in piquing his interest into delving into options when we were chatting a few years ago on another site (am I right here Wayne?). Hence the gratification seeing someone you’d chatted to about options in the past become a “monster” practitioner in their own right…

I do hope we’re not scaring people away, I’d be more than happy to go through the basics and up if there’s interest (and I’m sure Wayne and Margaret is the same, between the three of us, I’d suspect we’d cover a lot of ground). So, the door is always open, and I’m happy to shed light on derivatives and how they work on this thread as best I can. Anyway, Rich, you seem to have established quite a presence here on ASF yourself (I’ve read quite a few of your considered comments while browsing through the many threads on this site).

As for the Johnston book, I’ve never read it, so I can’t comment – I’ll pass that one back over to Wayne (seems I have yet another text to add to my to read list!).

McMillan’s “Options as a Strategic Investment” on the other hand is another matter. It is often described in professional circles as “the options bible”, with good reason. McMillan and Natenberg is a powerful combination if you want to get into advanced concepts.

McMillan is easy to read, and very thorough. I refer to it constantly, especially when I’m considering more exotic strategies. The text covers a range of market conditions, and carefully explains how to construct appropriate strategies for different market conditions, and goes into detail about the finer points of selecting the right options. But it’s an advanced text, and probably more suitable for intermediate options traders and up.

If you want a good ground floor to intermediate text, Guy Bower’s “Options: A complete guide for investors and traders” would be more suitable for beginners. The beauty here is that it will stand a new player in good stead for a long time, giving an excellent grounding for development. Also, it’s written by an Australian, with local conditions in mind as well as overseas markets which is a plus.

Interestingly Wayne and I have not read each other’s texts, but I had heard of Cottle before – he has a good reputation in options circles, so I suppose I’ll have to read up on him too!


Regards


Magdoran

[wayneL]

Re: Johnstons book

http://www.amazon.com/gp/product/0471226858/qid=1149598342/sr=1-1/ref=sr_1_1/102-1029944-0335331?s=books&v=glance&n=283155

It's mainly about futures options, and it's not a book for beginners as it assumes a knowlede of the basics.

It's not a book "about" options, it's about writing strategies, seasonals, non seasonals, statistics and a good dose of humour thrown in for amusement.

It is a good read IMO, but very different to Cottle, McMillan et al.

[swingstar]

Hi guys

Great thread...

I've been swing trading for a while using Dave Landry's techniques, but applying them to options instead of outright shares. I usually just buy calls/puts at the money or first in the money with 1-2 months left until expiry. So far have been doing pretty well (15-35% a month). I've also applied position sizing techniques from Tharp's books.

I still consider myself a major newb, so keep up the good discussion. I only knew what delta was before this thread!

;)

[sails]

Hi Magdoran,

Thankyou for the detailed reply (Post #63) and my apologies for taking so long to reply. We've been busy with visitors over the last few days, so I've managed to keep up with the reading of new posts, but wanted to take a bit more time to post a reply.

Re the bull call spreads, I think Wayne hit the nail on the head where the delta of both options ends up being too close - on a close spread there may only be a net delta of about 0.1 or 0.2. If that's the case, then obviously the spread needs to be widened, but then that begins to increase directional risk making the OTM a better risk to reward. However, in a slow move, a spread would certainly outperform the long call/put. Always trade-off's in options!

One thing I'm puzzled is that you've found vertical credit spreads have worked better than vertical debit spreads. If they are positioned at the same strike and in the same month - aren't they completely interchangeable? I've compared these in Hoadley and they seem identical. I can understand that an OTM bull put would behave differently to an OTM bull call as they are positioned at different strikes. I haven't done live comparisions on these - so would be interested on what you have found.

When I did the Optionetics course, they taught that you should always go out a minimum of 90 days for debit spreads and less than 45 days for credit spreads - but I have since understood that both spreads benefit from the same greeks if at the same strikes and expiry month, so they should technically perform the same. Obviously there is a cost of brokerage to close them which is not the same - the bull call expires worthless if it's wrong and the bull put expires worthless if it's profitable.

Would like to look into the diagonals a bit more - just wondering if you have a recent example you might be willing to share? Doesn't need to be a real trade - just to give a better idea. Woud be interested to see how far OTM you would go with your long and also how far out in time.

Will read through the other posts (you guys have been busy typing!) in more detail again sometime and will add any other comments or queries another day!

Thanks again for sharing,

Margaret.

[RichKid]

Hi Magdoran,
Thanks for all the help, picking up bits and pieces here and there, most likely will revisit this thread once I get into options seriously, may take years to feel comfortable! Currently just buying straight calls and puts. Thanks for the tips on the books, I do like Guy Bower's book, I'm so glad he published it instead of spruiking it as a weekend workshop.

Wayne,
Looks like Johnston is a bit too much for me, might give it a miss for the moment- thanks for the feedback.

Swingster,
Sounds like you're doing quite well, hope to hear of your adventures on ASF, feel free to start a 'follow my trade' thread if you like on options. We have a thread on real time examples of trades some members make in the Trading Tactics forum. Must be quite a bit of activity at this time of year with prices going all over the place.

[swingstar]

Thanks RichKid. I'll think about doing that soon.

Re: activity, I've only been holding some AMC puts for the last couple of weeks. I reached my target for May so decided to stay out of the market whilst it's so volatile and unpredictable.

[wayneL]

When I did the Optionetics course, they taught that you should always go out a minimum of 90 days for debit spreads


I don't get that one Margaret! Presuming the debit spread is ATM (i.e. the bought option is ITM and the written option is OTM), that amount of time, and particularly when IV, is high is going to flatten delta right out.

I mean thats fine if that is what the trader wants... as in a vega play with a directional bias, or specific time horizon. But thats not necessarily what a trader might want. I have no hesitation in entering atm verticals 30-60 days from expiry, if I'm after some delta and positive theta (presuming things go to plan).

Remembering, when playing an atm vertical, we by definition have an expectation of not much higher that the higher strike. Therefore one can get delta a lot cheaper (in other words less number of spreads and therefore less contest risk) with nearer dated options.

Lets never forget contest risk. With a straight $27.50 call we can get 1000 deltas with the equivalent cost of 6 of the above spreads. It is a big consideration not taken into account often.... particularly if we plan entering and exiting before expiry

For instance lets say we have XYZ @ $30 IV @35%. We want a $5 ATM spread, ie long $27.50 call and short the $32.50 call. Lets say we want 1000 deltas.

We can get 1000 deltas with 20 spreads with a 45 day till expiry series, plus some decent positive theta.

If we take a series with 135 day till expiry, we will have to buy 34 spreads to get our 1000 delta, with all the increased contest risk and negligable theta... YUCK!

The longer spread will have more vega, and that is a consideration that should be taken into account, but for the shorter term swing trades we seem to be mostly concerned with, I'll have the nearer dated spread thanks :D

Not forgetting, if the time horizon is 4 months, then fine, take the longer ones.

I just hate it when these jerks say you should "always" do this or that. As you said Margaret, there are always trade-offs with options. We should be encouraged to trade-off the greek we don't want for the one we do want.

Cheers

[sails]

Warning - options jargon to follow - so if you're not into options suggest you pass ;) .
However, those that have an interest in options, I really encourage you to persist with these types of posts as difficult as they may seem and try to learn the jargon. In the last 3 years of learning options it has been discussions like these that helped me more than seminars, etc in becoming fluent in the options "language" and understanding of the greeks. Like any other career, we have to learn the necessary jargon if we are going to improve our chances of doing well at it. While it doesn't guarantee trading success with options, it does help to eliminate unnecessary mistakes due to lack of knowledge :2twocents



I don't get that one Margaret! Presuming the debit spread is ATM (i.e. the bought option is ITM and the written option is OTM), that amount of time, and particularly when IV, is high is going to flatten delta right out.
I agree Wayne - just checked their manual to make sure I had it right - and there it is in print! The rationale given at the seminars was that with a debit spread you are buying premium so you must have more time and, of course, the opposite for credit spreads. Anyway, I believe it is more to do with the positioning of the spread rather than just a blanket rule for all debit or credit spreads, eg. with an OTM bull call spread (or it's ITM bull put counterpart) it may be better to buy more time due to negative theta whereas an ITM bull call (OTM bull put counterpart) starts off as theta positive so technically better with less time.

I haven't traded OTM bull call spreads further out, but have read of others that have with quite good results. I really don't like the trade off of such a small delta position!


Remembering, when playing an atm vertical, we by definition have an expectation of not much higher that the higher strike. Therefore one can get delta a lot cheaper (in other words less number of spreads and therefore less contest risk) with nearer dated options.
Spreads in near dated options do work well on a slow move, but since I actively hunt out potentially explosive moves, they seriously cap profits when right. If I don't get the move I want, can always spread the long off into a calendar or a vertical - lots of options (pun intended :) ).

However, I usually start with a smaller number of long calls or puts to get the deltas I want (in preference to placing a larger number of spreads with the associated contest risk) and then adjust if/as necessary. However, no matter what strategy is being used, it's always important to know which greeks are at risk and how we plan to manage that risk.

[Magdoran]

Hello swingstar,

Sounds like you’re heading in the right direction. Also, while I don’t want to make broad statements about the current market here, I think your approach of staying out of the market when you perceive that there is considerable risk, and are unsure what the market conditions are is very sensible, especially when using unhedged leveraged instruments.

Well done on the AMC trade, and sounds like the way I trade sometimes, exiting at a price and time target (at least a partial exit to lock in profit). This is an effective method of swing trading, and if used correctly keeps profitable trades from becoming losers.

Also, getting your positions size right, ala Van Tharp is critical in my opinion to managing risk, so well done there too.

As for the discussions on this thread, as you can see, there are so many approaches to choose from, which is why it takes a long time to become really proficient in options trading in a broad sense, but don’t make the mistake of believing you have to know all the nuances. You don’t. Sometimes it makes sense to stick with a strategy you know, and become proficient using it. Then you can slowly add to you repertoire at your own pace.

I think there are many roads to success here, the important thing is to simultaneously be effective in the field while growing in your knowledge. Some options players focus solely on the non directional strategies like condors, butterflies, strangles and straddles. Others are primarily directional, using straight calls/puts, bear calls/bull puts, bear puts and bull calls, ratio back spreads, diagonals, etc. Some are “Greek players” focusing on volatility, gamma etc.

The trick I think is to find out what works for you, and you will know this intuitively. But the key is to fit the strategy to the conditions, or fit the conditions to your favourite strategy (seek markets that conform with your preferred strategy).

Interestingly Wayne and I are similar in that we like trading our favourite markets, and fit our approach to the market, while others scan for a market condition and have a favourite strategy. Both approaches can work, it’s up to the individual.

Glad you are getting something out of the discussion, and please feel free to ask both the silly and the hard questions!


Regards


Magdoran

[Magdoran]

Hello Margaret,


Hope you had fun with the visitors (although it can be nice to get back to normal too, can’t it?). No problem with replying, we all have higher priorities in our lives, don’t we?

Ok, here’s some points to consider about Credit vs Debit spreads:

Debit Vs Credit Spreads – Bull Calls Vs Bull puts, and Bear Puts Vs Bear Calls:
The key difference is the effect of time. Time is detrimental to debit spreads, while it is helpful for credit spreads. If the underlying goes sideways, the credit spread if positioned and entered correctly has a better chance of either becoming profitable, or at least breaking even than a debit spread.

Of course, if the underlying moves in your favour, you may look to wind out the position at a certain target, in which case both strategies do well. Beware though that a real risk to both positions is slippage based on the width of the bid/ask spread. If the move is very favourable however, the credit spread expires worthless though reducing 2 legs of brokerage, where the debit spread requires some transaction to close it.

The strategies are quite different in that a credit spread is benefiting from the time decay if the underlying doesn’t move much. The debit spread will make a loss in many conditions where the credit spread will make a profit, or at least break even. Even in loss situations, the debit spread will tend to fare worse, since you should really be managing these positions, and winding them out before expiry if they are going wrong.

Be careful of comparing exact or even equivalent strikes when you are dealing with a put spread and a call spread too, one being a debit spread and one being a credit spread. Don’t just look at the risk and reward chart at expiry; this only gives you half the picture. Have a look say 8, 10, or 15 days out from expiry and see the difference on your chart (I don’t know if Hoadley’s can do this?). Their natures are quite different, and the skews are often different - the POD/risk chart actually diverges as you approach expiry.

The point is that you may need to manage the credit position before expiry, and wind it out. If you try to do this with the debit spread, the theta decay is likely to be unfavourable. This is where the difference is most notable. Of course there are other variables involved such as IV and how the underlying is moving. You really want to enter the bull put/bear calls when you think the underlying is likely to move to a favourable forecast price within the projected time frame.

There are some important points to note here about entering a credit position:

• You are looking for a trending underlying to trade.
• Look for favourable IV skews
• Should have at least a 1:1 ratio of risk to reward or better.
• They work better in high IV conditions.
• Time value premium is greatest ATM, so this is the area you want to sell in.
• Aim for around 30 days to expiry
• They are best entered on a counter trend against the main trend for the period selected (and it is at these times that the risk/reward ratios can move heavily in your favour – like 2:1, or even 4:1 in your favour – but this requires a bit of luck on the day, and a knowledge of how to finesse a good entry).

If the underlying for example moves slightly in your forecast direction, but not as far as projected, think about the effect on the two spreads. The debit spread is losing value since the theta decay is detrimental to the more near the money bought position (as opposed to the credit positions sold strike), and the OTM sold position while compensating doesn’t lose as much value (as opposed to the credit spreads bought strike losing value more slowly). A lot depends on a range of factors – where in the money you entered, how far the skew was in your favour, where the underlying moves, what IV does…

Think about this though. If the underlying goes nowhere, what is IV likely to do? Hmmm, go up or down? If the move is sideways, and there isn’t any news or events coming up (like reporting time), the IV is likely to fall, or at least not rise, isn’t it? Which spread do you think will benefit from falling IV? Consider that the objective of the credit spread is to sell to get a credit, and the aim is to keep as much of this credit as possible.

Traps for credit spreads:
Beware though, there is a catch! That is the prospect of being exercised, so be careful about selling too far in the money with too short a time and not enough time value premium sold. This is especially true for call spreads where you can end up owing the dividend, so be careful. If there is a prospect of early exercise, it is worth considering winding out the position pre-emptively to avoid this kind of risk.

Morphing:
Another concept is how to morph these positions. If the underlying in your view has clearly reversed and is going against your forecast direction, and in your considered opinion is likely to reach a target in the opposite direction, you may consider just buying back the sold option, and reversing your net direction. Sure, you buy back the sold strike at a loss, and it is risky changing direction, but if you think the probability is sufficient, reversing can sometimes be a profitable choice. But please exercise caution here, this is an advanced trading approach for experienced traders.


As for the Optionetics approach, I suspect that they have tailored the bull call spreads to the US market, and favour the OTM approach over the ATM/ITM versions. The main aim is to have small debit amounts, and get a risk/reward graph with more maximum profit potential to maximum loss (they describe this sometimes as “bet a Volkswagen against a Ferrari” – no offence to VW drivers!). The aim is to select the best bull call spread which has the most chance of success combined with a favourable risk/reward graph and a low debit entry. They also try to avoid theta decay in debit positions, presumably to reduce this risk for part time traders…

How’s that Margaret? Sorry, but the diagonals are even more involved, so I’ll have to find time to post that one up later (pressing things to deal with this week)…

Regards


Magdoran

[Magdoran]

Hello Richkid,

Great! Hope the reading goes well. Take your time though, this stuff takes a while to get used to, and to actually trade for real is a new dimension in itself.

You are right in your comment that it takes years to really develop using these instruments – I’m learning every day!

Regards


Magdoran

[sails]

Hi Magdoran,

Thanks for the reply, however, I'm not sure that we are talking apples for apples here with the debit / credit spread issue though - so have put some thoughts below:


...The key difference is the effect of time. Time is detrimental to debit spreads, while it is helpful for credit spreads. If the underlying goes sideways, the credit spread if positioned and entered correctly has a better chance of either becoming profitable, or at least breaking even than a debit spread. ...
If they are at the same strikes and expiry month, they form a "box" spread. I first learned about them as well as other synthetic equivalents from Cottle's CWS and also Natenberg and McMillan explain boxes in their books. As an example, I just had a quick look at NAB currently trading at approx $35 and the June $35.00 / $34.50 box is priced as below:

Strike Option Bid /Ask Mid Price
$35.00 Call .63/.67 .65
$34.50 Call .94/1.00 .97
= Total debit (risk) of 32c for a bull call with a max profit of 18c.

$35.00 Put .51/.55 .53
$34.50 Put .33/.37 .35
= Total credit (max profit) of 18c for a bull put with an 32c risk.

I'll keep an eye on the progress of this box spread - as it is most unlikely that the box will ever be worth more than 50c meaning that when just trading one side of the box as a debit or credit spread, they technically should behave in the same way and time and IV fluctuations should affect both in the same way. In fact, if it did move away from the 50c mark, I would first be looking for the reason why (eg divdends, etc) otherwise it would present an arbitrage opportunity = free money - and we know the MM's don't do that!

Of course dividends, capital returns and the like do change the pricing of the box and some new option traders mistakenly believe that there is an arbitrage opportunity not realising the risks they are taking on with such a position.


... If the move is very favourable however, the credit spread expires worthless though reducing 2 legs of brokerage, where the debit spread requires some transaction to close it. ...
Totally agree that this is so - but also the debit spread doesn't need closing out when it's wrong which reduces brokerage. However, if one has a large win rate with these, then it would be best to trade the bull puts to save on fees.


...Traps for credit spreads:
Beware though, there is a catch! That is the prospect of being exercised, so be careful about selling too far in the money with too short a time and not enough time value premium sold. This is especially true for call spreads where you can end up owing the dividend, so be careful. If there is a prospect of early exercise, it is worth considering winding out the position pre-emptively to avoid this kind of risk. ...
Agree - sold puts assignment don't have the risk of owing the dividend as sold calls do and is one of the reasons that dividends skew the box giving the illusion of a risk free trade.


As for the Optionetics approach, I suspect that they have tailored the bull call spreads to the US market, and favour the OTM approach over the ATM/ITM versions. The main aim is to have small debit amounts, and get a risk/reward graph with more maximum profit potential to maximum loss (they describe this sometimes as “bet a Volkswagen against a Ferrari” – no offence to VW drivers!). The aim is to select the best bull call spread which has the most chance of success combined with a favourable risk/reward graph and a low debit entry. They also try to avoid theta decay in debit positions, presumably to reduce this risk for part time traders…
Actually the example in my Optionetics manual is an ITM/OTM bull call spread, but agree that in the seminars they would teach selecting the best risk to reward as you have outlined above, however, their bull put example is an ATM/OTM spread. I discussed this in a post to Wayne today where I believe that it actually depends more on where the spreads are positioned to determine their sensitivity to theta - not because they are a debit or credit spreads. No question that an OTM/ATM bull put will behave differently to an ATM/OTM bull call (where the bull put sold strike is ATM and the bull call sold strike is OTM),

No rush on the diagonal question - when you have time is fine!

Cheers,
Margaret.

[wayneL]

- just checked their manual to make sure I had it right - and there it is in print!

Hi Margaret,

I happen to be the proud owner (NOT) of "The Options Course" by Georgie Peorgie Fontanills. ( The chief clown at Optionetics for those who wonder who he is ) I just looked up the section on Verticals and this prompted an extended rant that my wife was forced to endure. She pretended to know what I was on about and agreed wholeheartedly... bless her.

Anyway, I think the whole chapter is a load of cobblers.

I'll pick one example to completley destroy the credibility of this cowboy.
Stock trading @ $44
Long 1 45 put @ $3
Short 1 50 put @ $7.50

This produces a rather pretty looking payoff diagram with $50 risk and $450 reward. Hey not bad 9:1 risk reward and we take in $450 credit... wonderful.

Two problems with this. 1/ We are theta negative unless the stock goes above ~$45.30 and our probability of profit theoretically is < %50. We NEED to be right with direction, and we need to be VERY RIGHT to get maximum profit from this spread

2/ the sold put is WTFITM (Way The F%$# In The Money). If the cost of carry for the stock holders exceeds the extrinsic value for the puts, they're going to start exercising early i.e there is a strong possibility of being assigned stock early. This is not catastrophic in and of itself, however our $450 credit has turned into a $4,650 debit PER SPREAD! Is the cash in the account?

What we will have ended up with is a synthetic long $45 call at $4650 each. Doh!

If one particularly wanted this payoff diagram it would have been far smarter to use calls instead of puts... no risk of early assignment.... or.... looking logically here, we're looking at quite an explosive move at $44 to $50+. Why not consider the $45 call? IE what we would have ended up with synthetically anyway, and for a small fraction of what the synthetic version wo0uld have cost us.

I can't believe Georgie doesn't know all this stuff. If he doesn't, then WTF? But it looks to me more like intentional subterfuge... intellectual immorality. It seems he is presenting these spreads in the most favourable light possible without introducing the attentant risks and disadvantages.

Poor Show!

[sails]

Wayne, it wasn't until I learned about synthetics, boxes, etc that I realised that there was never any need to do an ITM bull put spread and struggle with wide bid/ask spreads). Much easier to the OTM bull call counterpart (same strikes) then, if the sold call doesn't have enough value to sell, as you say, just buy the call - fees are less, slippage is better, etc.

Undertanding synthetic equivalents has made option jigsaw puzzle pieces fit better into place.

[wayneL]

Wayne, it wasn't until I learned about synthetics, boxes, etc that I realised that there was never any need to do an ITM bull put spread and struggle with wide bid/ask spreads). Much easier to the OTM bull call counterpart (same strikes) then, if the sold call doesn't have enough value to sell, as you say, just buy the call - fees are less, slippage is better, etc.

Undertanding synthetic equivalents has made option jigsaw puzzle pieces fit better into place.

Yes that was the lightbulb for me too, Margaret.

... and folks, guess where Cottles book starts:

C O N T E N T S
C H A P T E R 1
Picking Up Where The Rest Leave Off - Synthetics 1


Cheers

[professor_frink]

just starting cottle now- I'll come back in about 6 months when I've read, reread and understand it :D

[Magdoran]

Sorry Margaret,


This is a fiddly subject, isn’t it? Perhaps I may not have explained myself very clearly, so I’ll try to clear a few things up here. The exercise I set out to discuss was that in my experience bull puts tended to be profitable more often than bull calls in practice, and I was trying to reason why this was. I did suggest that they were more likely to succeed IF they were entered correctly in the right conditions.

I accept that some bull calls may outperform some bull puts both in theory and practice, just like any two strategies – sometimes the risk to reward is favourable, and sometimes it isn’t. The objective was to determine the strategy we feel is most appropriate to meet our risk to reward requirements.

The particular results you came up with from the spreads you chose is in part because you chose strikes that are not equivalent, or for that matter realistic if one was to enter either strategy. Firstly, the bull call spread does not have good risk to reward parameters, nor does the bull put spread, which also does not follow the parameters I set out in the previous post.

Secondly, in the example the two strategies use the same strike price levels for two totally different applications. For a start, 34.50 is 50 cents OTM for a put, while it is 50 cents ITM for a call. These are not equivalent strikes. Does that make sense? What is happening here is that we are comparing an ITM debit spread with an ATM credit spread. This is why we have ended up with some odd figures, wouldn’t you agree, and why this starts to become confusing?

In effect, I was not intending to look at spreads with arbitrarily fixed strike prices, but at the overall viability of different strategies to a situation in the real market. I could also find examples where we pick two strike prices that have a radically different result to the one published, reversing the effect, but this isn’t really relevant to the points I was trying to make.

Try this approach on for size: Try selling the NAB June $36 put, and buying the June $35 put for the bull put spread. (Have a look at the diagram attached – this is the yellow lines on the chart).

Compare this with buying the $35 June call, and selling the $36 June call for the bear call spread. These have a very similar risk to reward chart (see the black lines on the attached chart). This is roughly the equivalent of the bull put spread in strikes.

The net situation is similar. Granted the charts are not significantly different. What is different is the way these play out in the market. In higher IV situation if you can sell the put in this case with a good skew, the time element is advantageous; this can be a great play to make.

Certainly if you can get a good IV skew on a bull call this is a plus too. The advantages I spelt out before though in the long run I think make the bull put a preferable play, but this is just my opinion. Sometimes another strategy looks better, and sometimes it doesn’t. But if you’re going to use bull calls, my suggestion is to also consider bull puts as an alternative (or the bearish equivalent), and be aware of the advantages and disadvantages of each.

Also, the volatility effects at these levels are quite different since one is ITM and the other is OTM relative to each spread. Also, the acceptable risk reward chart for each strategy will be based in part on price and time objective and volatility outlook.

The big plus in my view is that the sold high IV tends to reduce the possibility of the skew moving against you, where this is sometimes a problem with bull calls. A point to note here is that some people only look at the expiry graph, but don’t consider IV effects days out from the expiry which is where the action usually happens. Bu this assumes you consider this when you enter.


Hope this makes sense Margaret.


Regards,


Magdoran

[Magdoran]

Hello Margaret,


Respectfully, I just cannot agree with your conclusion in Post #94. Again, are you sure you are choosing equivalent strikes, not exact strikes, (since exact strikes for a put and a call are radically different). If you are talking about the configuration I posted above, then the outlay is about the same, and the risk to reward parameters at expiry is similar.

I do agree with the idea that sometimes it's worth just going for an OTM single option series, this makes a lot of sense from a risk to reward perspective. Sometimes you can combine a bull put with an OTM call which is a bit like a synthetic, but with limited risk…

But I don’t agree at all with the idea that an ITM bull put spread is necessarily going to have wide spreads, and this is certainly not true for many traders I’ve worked with during the bull market. In fact in my experience the reverse is true.

The bull calls yielded less on average, and lost more, were harder to get a good skew in, and on the way out the skew often moved adversely – not as much of a problem for bull puts… but maybe this is a freaky skew that you have the opposite experience to mine, but maybe it is based on our T/A styles and time frames.

If you have a preference for bull calls, and it works for you, great! Please, stay with what works for you. But for me, I have the opposite experience.

Anyway, I think we’re going to have to agree to disagree on this one (which is common for traders – I like chocolate and someone else loves sticky date pudding). As Wayne says “horses for courses”.


Regards


Magdoran

[wayneL]

What about assignment risk Mag?

[Magdoran]

Hi Wayne,


I did list upfront being exercised as one of the disadvantages to be aware of for credit positions - so any decision should consider all these factors to determine which way to go, shouldn't it? It’s based on your forecast view of the underlying, isn’t it?

Anyway, you can get exercised with a bull call (less likely, and easier to deal with, but a nuisance just the same).

If the risk of being exercised is too high, how hard is it to wind out the position? If you entered as suggested with sufficient time value premium, this should reduce the risk. This kind of a position is a trade off, and should be used in the right conditions just like any other strategy.

Mag

[wayneL]

Anyway, you can get exercised with a bull call (less likely, and easier to deal with, but a nuisance just the same).

Mag

Yes you can. but the short call is OTM and would require the underlying travelling past the sold strike. However because the burden cost of carry is upon the call seller, early assignmnent is most unlikely.

However with the ITM bull put, the sold strike is already substantailly ITM and inviting early assignment because of the put holders COC. Even with sufficient time value, alls you need is a few ticks against you to whittle that away. Unwinding in this situation doesn't necessarily prevent assignment, you may still end up with stock if the OCC has already notified your broker of assignment.

It's a shame there weren't more european style options around because of this nuance.

[sails]

Hi Magdoran,

No problem with agreeing to disagree - it makes for more interesting discussions when these things are bounced around :) Oh, and I like chocolate and stick date pudding - in fact made sticky date for our visitors! But we are all different, often see things differently and that's what makes life interesting.

While happy to share my views, I still like to keep an open mind to what is working for other option traders so look forward to further discussions and leave the credit vs debit spread alone.

I do agree that if something is working for you, don't change it. For reasons I mentioned a few posts ago , I'm not too keen on bull calls either - still like to start off with long calls or puts then perhaps morph into something else if necessary.

My own experience is that the further ITM the option is, the MM's seem to widen the bid/ask spread. Just been a general observation, however, as I havent been trading them I may well be incorrect on that one - my apologies if I've got that wrong.

I am genuinely interested in what you have shared and will paper trade some of your ideas including the NAB $35/$36 bull put that you've suggested to get a feel for it.

Thanks again!

Margaret.

[Magdoran]

Hello Margaret,


Aha, so we share another passion - CHOCOLATE!

As for discussions, I’m happy to chat to an extent, but since there is so much ground to cover in so little time, I prefer to focus on broad principles, and keep the momentum going. I hope that’s OK with you?

Hey, the bull put strategy displayed for NAB was purely hypothetical; I certainly wouldn’t be trading this strategy right now from a T/A perspective. This kind of spread is good in a trending bull market, not a correcting/consolidating one.

The idea is to enter on the pull backs in a bullish drive looking for a fast move down to get set when the IV kicks up, and there is sufficient action as players push the option prices around while you have an order in with a set credit amount in your favour. The spreads can really move around some days, and this is the trick to getting set with a good ratio. But I wouldn’t be playing this kind of trade in this uncertain choppy market.

There are specific patterns I look for, and the whole approach usually includes some OTM diagonals too. The key conditions are not evident anywhere (and may not be around for a long time). You do want some trend in evidence.

Sorry, but there are so many aspects to trading, and perhaps we could look at how market makers work, and talk about the different players there like optiva and susquana, and timberhill to name a few…. There are all sorts of tricks to getting set at an advantage, and observing the market makers and other players is key to this, but this is a whole topic in itself.

If you really want to get into the nitty gritty sometime, happy to chat about it, but it may be unsuitable for this thread…


Regards,


Magdoran

[Magdoran]

Hello Wayne,


Re your post #101: Yeah, didn’t we cover the risk of assignment in posts #90 and #100?

Sure, assignment is more likely to happen to bull put spreads than for bull call spreads, and said this too. Each strategy has a trade off, and this is one of them. That’s why I suggested how to manage this kind of strategy, and made the comment about this pitfall.

Now, if the market moves strongly against you, any directional position is going to suffer, isn’t it? Different strategies will fare differently, but most will take a hit in a strong adverse move. If you decide to enter this strategy you should do so knowing the maximum loss, and how to manage the position.

Re assignment – can’t happen if you’ve closed the position, and you’d know immediately if you were assigned, you’d have the shares in your account and a big red number. It’s happened to me, and it’s no big deal. That’s why you should get set with a good deal of premium, to reduce the risk, and offset any assignment activity if it occurs.

Don’t forget, you still have the open long puts for protection, and they will have a value if you buy the shares on assignment day to fulfil the contract, or you could also exercise the long puts if required.

So, you raised a good point here Wayne, perhaps you would be kind enough to outline the mechanics of how assignment works, and your experiences on either side of it?


Regards


Magdoran

[wayneL]

Hello Wayne,


Re your post #101: Yeah, didn’t we cover the risk of assignment in posts #90 and #100?

I hadn't considered that we were speaking of ITM credit spreads. This is something which is not normally considered in my circle of colleagues, precisely because of the assignment risk.

Normally when speaking of credit spreads, OTM is the usual config. Apologies for not picking this up. There must still be a few neutrons richocheting around upstairs.


Sure, assignment is more likely to happen to bull put spreads than for bull call spreads, and said this too. Each strategy has a trade off, and this is one of them. That’s why I suggested how to manage this kind of strategy, and made the comment about this pitfall.

Now, if the market moves strongly against you, any directional position is going to suffer, isn’t it? Different strategies will fare differently, but most will take a hit in a strong adverse move. If you decide to enter this strategy you should do so knowing the maximum loss, and how to manage the position.

Agreed


Re assignment – can’t happen if you’ve closed the position, and you’d know immediately if you were assigned, you’d have the shares in your account and a big red number. It’s happened to me, and it’s no big deal. That’s why you should get set with a good deal of premium, to reduce the risk, and offset any assignment activity if it occurs.

Re asignment: I stand corrected.


Don’t forget, you still have the open long puts for protection, and they will have a value if you buy the shares on assignment day to fulfil the contract, or you could also exercise the long puts if required.

Yes, But a number of things are now possible, depending on capitalization and the broker. We may have very expensive call options, we may have to involuntarily exercise our long puts, we may have to correct the stock position with an offsetting option to avoid coughing up more cash, the long stock may be immediately closed out and we end up with a long put only.

None of which is desirable.


So, you raised a good point here Wayne, perhaps you would be kind enough to outline the mechanics of how assignment works, and your experiences on either side of it?

The mechanics of this is available at any of the options exchanges sites.

[sails]

Hi Magdoran,

Sounds good to keep the momentum going on these discussions, but if I'm not clear about something, I like to ask questions until it becomes clearer or understand the other person's viewpoint.

Yes, I realised that the NAB bull put was hypothetical especially under these market conditions. Don't worry - I never trade a new idea live until I've tested it, understand it and have a management plan!

I was only interested in an example of your diagonal to get an idea of where you are positioning the strikes and how you tie it in with your bull puts. Like Wayne, I was wrongly assuming that your bull puts were OTM and the NAB hypothetical showed otherwise. Quite happy with a past example when conditions were right - but agree that this would be a topic on it's own.


...Sorry, but there are so many aspects to trading, and perhaps we could look at how market makers work, and talk about the different players there like optiva and susquana, and timberhill to name a few…. There are all sorts of tricks to getting set at an advantage, and observing the market makers and other players is key to this, but this is a whole topic in itself. ...
This would be really interesting and would certainly like to understand more how they work (especially our local MM's) and would love to hear of any ways you've found to get a better advantage - sounds great!

Cheers,
Margaret.

[Magdoran]

Hi Wayne and Margaret,


Sorry guys, was (and am) under a lot of pressure to produce a whole range of documentation (professionally, domestically, comments for this site – I promised hissho an XJO scenario I’ve been doing in bits for example) – add this in with trading imperatives, and a seminar to prepare for… let alone home life… you get the picture. I was feeling frustrated late last night (and very sleepy - I don’t stay up to trade the US market) that you guys didn’t magically know everything I do… hey, why don’t you? Hahahaha…

So, I’m a little bit more objective this morning, and of course you’re going to ask questions and raise issues and try to understand where I’m coming from… I suppose I assumed we were covering all of this at a high level and I wouldn’t have to go into the detail.

On reflection, I can see that is precisely where you’d like to go, right hard into the detail on all levels, the unseen things like how to assess and deal with the actual risks, how to understand and fox the market makers, etc. All important issues.

My focus was on finding time to write more technical comments like on the diagonals for instance (then ratios, compare morphing, compare models, etc) but at a high level, then come back and talk about the nuances. What I might do is to back burn all of this, and adopt a more open discussion format on the detail for a while, and cover the high level areas as the thread dictates at a significantly slower pace. Works for me…

Anyway, it’s “Wayne’s World” here! Hahaha


Must away!


Magdoran

[sails]

Hi Magdoran,

I have a pretty good understanding of options in both theory and practice, so there is no need to go into such detail of option basics. If I ask a question, it is on the assumption that we both have basic options knowledge and if it's over my head, I'll let you know! Obviously there will be different view points from time to time as we've already discovered, but that's what makes a good discussion.

Regarding market maker activities, I do have a basic understanding of how it works and how they hedge. Cottle's book devotes a whole chapter to Market Makers and explains the hedging mechanisms of conversions and reversals. My main interest was piqued when you mentioned our local MM's as I thought you may have had some other interesting information that was more applicable to the local market. So, definately no need to go into the basics - but if you have any practical suggestions in how to improve on order fill, etc - that would be great.

Sounds like you have a lot on your plate at the moment - so please do not feel under any pressure to reply to these topics until you feel you have more time.

Cheers,
Margaret.

[wayneL]

Anyway, it’s “Wayne’s World” here! Hahaha


Must away!


Magdoran

Because I have an opinion? hmmmmmmmm!

[Magdoran]

Wayne: Meaning: "it's your house (thread) - your'e the moderator - not trying to steal your thunder".

Margaret: I know you are highly proficient at options...

Now we're really getting our wires crossed...

What's going on here - we've gone from cordial to less cordial for some reason. Am I missing something?

Sorry if I've caused offence... none was intended.


Magdoran

[sails]

Hi Magdoran,

No offence at all - just trying to spare you time in typing so much detail as you so many other commitments. That's all I was trying to communicate in my post as I know what it's like to be really busy. Quite happy to wait until you have time to share some of your ideas :)

Cheers,
Margaret.

[wayneL]

Wayne: Meaning: "it's your house (thread) - your'e the moderator - not trying to steal your thunder".

I rarely have thunder, and usually only after a high fibre meal :eek:

Don't worry about stealing thunder, if you have something to add, go ahead and say it. No problems here.


What's going on here - we've gone from cordial to less cordial for some reason. Am I missing something?

Mag,

It's the lack of body language. We can misread each other on these forums. But most on this forum don't hold grudges at all anyway. Even if the debate becomes "robust" it doesn't mean anything really.

But as traders we are good at offence and parry, it's what we do to survive. Discussion inevitably reflects this. Don't worry about it, we're all friends at the end of the day.

Cheers

[cuttlefish]

Great thread people - unfortunately I've got nothing to add since I'm new to options but have really enjoyed reading the commentary so far.

[sails]

Here is a link to the free "Options Trader Magazine" for May and June :)
http://www.optionstradermag.com/v2ads.htm

Edit: Just noticed that it is possible to download all the previous issues by clicking on the "Back Issues" tab on the left hand side of the screen.

[Mofra]

Sails,

Thank you very much for posting the link on behalf of all occasional lurkers like myself - finding the credit spread vs debit spread article very interesting ;)

[sails]

Here's an interesting article on debit vs. credit spreads by one of the Optionetic's instructors - so obviously they don't all agree on this issue. I believe the author was previously a market maker: http://www.optionetics.com/articles/archive/article_archive_full.asp?idNo=14840&intChoice=0&mType=3&mSearch=kramer

[Magdoran]

Here's an interesting article on debit vs. credit spreads by one of the Optionetic's instructors - so obviously they don't all agree on this issue. I believe the author was previously a market maker: http://www.optionetics.com/articles/archive/article_archive_full.asp?idNo=14840&intChoice=0&mType=3&mSearch=kramer


Aha Margaret, I can see what you were getting at here...

Sure, this Scott chap is quite correct about the theory... Where I’m focused is finessing skews in my favour, and exiting with a beneficial skew, and morphing.



When a trader is contemplating buying a call spread or selling a put spread at the same strike prices he/she is undertaking a major waste of time as they are the same thing – period. Let me clarify before people's diastolic pressure go through the sphygmomanometers. I am stating that the two spreads are accurately priced with no arbitrage potential, of the same month, same underlying, etc. “How can that be, Kramer”? I really don't know, and I am still trying to figure it out, but it is so.”

What he’s talking about is a situation where there is no skew. If the market traded perfectly all the time, then he’d be absolutely correct, there would be no difference in the two strategies as specified above, except perhaps the lack of brokerage for bull puts if they expire worthless.

Where there is a difference is in the way skews come about, and how IV will affect different strikes. I’ve just found that in the market in Australia it was easier to enter bull puts with an advantageous skew over bull calls, and certainly so on exit. Of course it’s possible for bull calls to have excellent skews too, but I just don’t see many here, but then I rarely look for these much anymore...

I did get one part wrong about using the term “exact strikes” in post 98. This is incorrect where you sell a $40 put for 0.85, buy a $41 put for 0.45 yielding a 0.40 credit, and buy a $40 call for 1.35, sell a $41 Call for 0.75 for a debit of 0.60. The risk and reward is the same.

Where this gets messy though is in the actual price you can get set at during normal trading (entry or exit), I have found from experience that you could get set with really good ratios for credit versions over debit. I don’t know why this is, but this has been my experience to date.


Regards


Magdoran

[ozambersand]

Hope you don't mind me bumping this thread, but I found it doing a search and it's got lots of stuff I need to check on now and then, so I would prefer it closer to the top! :) :rolleyes:
PS Thanks for all the work that everyone contributed to it.

[chops_a_must]

Just a couple of questions. I'm motoring through those options books you recommend Wayne, some great stuff. Read the covered call section in the Mcmillan book twice now, and am a third through the Natenburg book. Should be doing study, but am enjoying them too much. :o

Just on delta neutral strategies... what happens if you get an early excercise whilst using this strategy? And is this still profitable? If the market thinks there are a lot of people using this, will it start hunting certain levels? A lot of people have claimed they were ruined because agents knew positions and were targeting them, didn't they?

And is this strategy even possible on Oz stocks? Considering in a lot cases, you would need several 100k worth for a lot of stocks.

Is there any way I can write puts, with the intention of being comfortable with being assigned, for a $50 dollar stock in Oz, without needing 50k? Only say, wanting 5k of it?

Also, is there any easy reference to the full list of optionable stocks on the ASX? And which ones only settle every three months, and each month.

What is the full cost in brokerage on IB, from writing and purchase, to excercise/ assignment?

Does the fact that ASX options are in lots of 1000, rather than 100 lead to the illiquidity problems in Oz options? And do you think they would be better off changing that?

Sorry for the questions. Just very enthusiastic atm. Cheers.

[wayneL]

My answers in blue.


Just a couple of questions. I'm motoring through those options books you recommend Wayne, some great stuff. Read the covered call section in the Mcmillan book twice now, and am a third through the Natenburg book. Should be doing study, but am enjoying them too much. :o

Just on delta neutral strategies... what happens if you get an early excercise whilst using this strategy? And is this still profitable? If the market thinks there are a lot of people using this, will it start hunting certain levels? A lot of people have claimed they were ruined because agents knew positions and were targeting them, didn't they?

There are different ways of looking at this, all via synthetic relationships. Realistically there are two instances where you are in danger of early assignment on short . ITM puts and calls where there it is about to go ex-dividend and there is a financial benefit for the call owner.

With euro style options (index) this is not a problem.

Let's say you are constructing an iron condor. You will have a short ITM put which could get exercised early. The answer is to construct an all call condor. People like to do irons for the credit, but at the end of the day there is not much difference, unless there is an issue with the spread. They are synthetically equal.

On the call issue, just watch for the ex div date is the obvious thing.

If you do happen to be assigned. It's a matter of re-evaluating where your at, and adjusting to suit. Lets say your assigned the short put in an iron condor. Now you have a leg of long stock. You can keep the stock and sell a call against it, and you have a synthetic short put again.

Will the market hunt levels? I don't know, but you should have a defence strategy in place.

On stocks, I don't go straight fro the condor. I'll do a credit spread and go delta neutral and start hedging with stock, roll, flip, or whatever if it goes pear shaped.

And is this strategy even possible on Oz stocks? Considering in a lot cases, you would need several 100k worth for a lot of stocks.

Is there any way I can write puts, with the intention of being comfortable with being assigned, for a $50 dollar stock in Oz, without needing 50k? Only say, wanting 5k of it? Not really. Not without the risk of the 50k position that I can think of.

Also, is there any easy reference to the full list of optionable stocks on the ASX? And which ones only settle every three months, and each month.

What is the full cost in brokerage on IB, from writing and purchase, to excercise/ assignment?

I don't know these two as will be different to US. Sails will know.

Does the fact that ASX options are in lots of 1000, rather than 100 lead to the illiquidity problems in Oz options? And do you think they would be better off changing that?

I reckon so. But don't have any evidence to prove it. But a lack of MM competition has a lot to do with it as well.

Sorry for the questions. Just very enthusiastic atm. Cheers.

Cheers, good questions

[VolTracker]

Here's a few links to ASX sites that might answer a couple of chops' qn's.

List of Optionable ASX Stocks
http://www.asx.com.au/data/option_securities.pdf

Option codes list
http://www.asx.com.au/data/options_code_list.csv

Excel file of option stocks, volatility estimates from MM's and Div's updated weekly (Note that the divs are not that reliable).
http://www.asx.com.au/data/volatility_and_dividend_parameters.xls

cheers all

[wayneL]

Chops,

Just re-read my answers... what a load of poorly phrased rubbish. I don't know how anyone could understand what I was on about. I think I'll have another go after some caffeine. :rolleyes:

[Nick Radge]

Its after 9am mate...try the one with the RED label...it might be in a different cabinet from the coffee though...:)

[Nick Radge]

Sorry, thats disrespectful for a class act. BLACK label...

[wayneL]

Actually, I've always been a fan of German wheat beer. But I now know what to bring if I'm ever looking for a bed in Noosa. :D

[chops_a_must]

Here's a few links to ASX sites that might answer a couple of chops' qn's.

List of Optionable ASX Stocks
http://www.asx.com.au/data/option_securities.pdf

Option codes list
http://www.asx.com.au/data/options_code_list.csv

Excel file of option stocks, volatility estimates from MM's and Div's updated weekly (Note that the divs are not that reliable).
http://www.asx.com.au/data/volatility_and_dividend_parameters.xls

cheers all

Thanks mate. I did find the optionable stocks thing last night.

You wouldn't happen to have any comments on the ease of trade with the flex options would you?

[chops_a_must]

I now know what to bring if I'm ever looking for a bed in Noosa. :D
A pillow? :confused:

[VolTracker]

The way I understand it, FLEX options can be requested by a financial inst on stocks where regular ETO's are not available. ASX site explains it better.

As far as trading goes, they dont have the usual Market Maker obligations so getting a reasonable spread can be difficult to impossible.

Looking thru the FLEX stocks yesterday there was dribs & drabs volume on quite a few of them so they must be tradeable at least.

ABS (67 contracts), ALL(12), FMG(50), GFF(5), IPL(1), LEI(4) ....

Personally, I have found getting filled very hit and miss so I rarely trade them now.

[chops_a_must]

The way I understand it, FLEX options can be requested by a financial inst on stocks where regular ETO's are not available. ASX site explains it better.

As far as trading goes, they dont have the usual Market Maker obligations so getting a reasonable spread can be difficult to impossible.

Looking thru the FLEX stocks yesterday there was dribs & drabs volume on quite a few of them so they must be tradeable at least.

ABS (67 contracts), ALL(12), FMG(50), GFF(5), IPL(1), LEI(4) ....

Personally, I have found getting filled very hit and miss so I rarely trade them now.

Thanks for that. I'd only be interested in writing covered calls, and writing naked puts for them, not actually trading them. Just wanted to make sure that that would be possible.

Thanks.

[MRC & Co]

Here is something I have been considering, do any of you guys buy DITM calls (as LEAPS) if you are thinking of going long for some time, as a way to gain leverage whilst negating added risk? And if you use this strategy, do you use it the majority of times in the aforementioned circumstances?

Also, another quick question, on option probability calculators, how come if you set the strike at the current price, and expiration for say 3 months, it gives you a 50/50 probability, when infact the market is prooven to trend up 70&#37; of the time?

Cheers

[wayneL]

Here is something I have been considering, do any of you guys buy DITM calls (as LEAPS) if you are thinking of going long for some time, as a way to gain leverage whilst negating added risk? And if you use this strategy, do you use it the majority of times in the aforementioned circumstances?Valid strategy.

But consider that vega (sensitivity to volatility changes) increases as you go out in time, so it can add risk if you buy at any old price. Best time to buy leaps with this in mind is when IV is cycling low. That way you can be long vega as well as delta.

Other greeks should be taken into consideration too. You will have to leverage 2x just to get the equivalent delta as a stock position and as gamma is also low with long dated options (but better when IVs are lower), the stock has to move in your favour a long way before the option starts to manufacture some extra delta.

You will also be paying up front for all those carrying costs.

There are pros and cons.

Also, another quick question, on option probability calculators, how come if you set the strike at the current price, and expiration for say 3 months, it gives you a 50/50 probability, when infact the market is prooven to trend up 70% of the time?

Cheers
Probability calculators, though definitely an aid, should be taken with a pinch of salt.

[MRC & Co]

Thanks Wayne,

Few things to think about there. I will have to get a better understanding of ALL the greeks. Have to keep reading over and over to let them sink in!

Start of this thread is probably a good place to go back too as it explains them better than most books I have found!

Thanks!

[stargazer]

Hi Wayne

I am looking to structure my trades so as to have a low exposure to the risk. I would like to ask what is wrong with working with this type of structure. I understand it at least..lol.



Buy 1000 XYZ for $12.00 a share......................cost 12,000
Buy 1 12.50 put option for $1 a share ......................1,000
Total cost .................................................. ........13,000

If stock goes against you and goes down potential max loss 3.84%

sell stock 12500
outlay 13000
-500

You can also write a covered call but bit tired to work it all out now.

Why is this type of set up so risky as you have indicated in the past.

Cheers
SG

[wayneL]

Hi Wayne

I am looking to structure my trades so as to have a low exposure to the risk. I would like to ask what is wrong with working with this type of structure. I understand it at least..lol.



Buy 1000 XYZ for $12.00 a share......................cost 12,000
Buy 1 12.50 put option for $1 a share ......................1,000
Total cost .................................................. ........13,000

If stock goes against you and goes down potential max loss 3.84&#37;

sell stock 12500
outlay 13000
-500

You can also write a covered call but bit tired to work it all out now.

Why is this type of set up so risky as you have indicated in the past.

Cheers
SG

Hi SG,

It's not that it's risky. You have limited your absolute downside risk to $500, that's fine.

But, you are trading other risks for removing that downside risk. You are paying someone else to take them on for you.

If those other risks are acceptable in exchange for limiting downside risk, you go ahead and put the trade on. If not, then don't trade.

Let's have a look:

* Your put option is 50c in the money. That means that *at expiry* you will incur maximum loss at any price up to $12.50 and you won't break even until $13.00. That means your stock could rise a full 8% and you still make a loss after costs.

* You are slightly increasing your contest risk, capital needed and carrying costs. Contest risk is brokerage and spread and you are adding at least one extra commission. You are using $13k for a $12k position and you are carrying that $13k position (loss of risk free bank interest received on cash).

OK here's a couple of things to think about:

* Always consider synthetically equivalent positions. What you in fact have in the above, is a synthetic $12.50 call option which you can buy for ~$600. If you like the above risk profile (the stock plus long put), you can achieve the exact same risk profile (once cost of carry on long stock is considered) with the long call.

* You are using much less capital, contest risk may be less (but certainly not more), and you are achieving exactly the same thing.

* Consider other strikes and expiries, think about which trade offs are best for you.

* There are other considerations, buts that's enough to think about for now.

Options are all about compromise, you are swapping one type of risk for another. That's good, because you get to choose which set of risks are most palatable to what you are trying to achieve.

Cheers

[MRC & Co]

Another strategy:

How many of you guys have at anytime consistently used bear call or bull put option credit spreads to eliminate directional bias (and risk) and gain some quick and consistent premiums?

I mean, in a bullmarket, wouldnt it give you a high probability return to trade bull puts due to the already evident probable directional bias, and in this current bear market, vice-versa? (i.e. trade bear calls?).

Especially on a shorter time-frame (no more than 60 days), to eliminate trend reversal and to maximise time decay. Whilst only trading OTM strikes.

Seems simple and like a rather consistent strategy?

Any thoughts?

Thanks

[Grinder]

MRC,

I share your sentiments, have been predominantly trading credit spreads of late for all the reasons you have listed. However, I do have some grievances with these types of plays, one being the capital that is tied up and another being insufficient premium that is generated from going OTM. This can be overcome at times by increasing position size or widening the cushion but taking on more exposure, which I don't like doing as I have an aversion to too much risk. Not too mention (which I will) finding an IV skew that won't hurt the spread too much or having to unwind to late in the game.
Nevertheless, it's still my strategy of choice till I learn more about options... but what would I know? been trading for only a few months so I'm sure some of the pros on this forum can provide better analysis as to the pros & cons.... would welcome this.

my :2twocents

[MRC & Co]

Thanks Grinder,

Yeh, the volatilty skew was another thing I was meant to throw in. But as you say, can take longer and more time on the sidelines.

I also agree, premiums would not be the greatest and the credit spread would tie up a bit of capital on margin.

Do they make you maintain your entire potential downside from the go, or only a portion and a margin call if it turns against you (crosses your closest strike)?

Cheers

[Grinder]

MRC,

I enter the trade with the total margin required (prem margin on market + risk margin) which they calculate using the asx margin estimator. In addition to this they ask for 100% of the calculated figure as the overall total margin they hold, which means those funds are frozen till the position is closed. Ofcourse, the figure would obviously change as the market does each day, thus adjusting my overall total margin required at the end of each trading day. :(

If any option traders out there use a provider that requires less margin, let me know.

[wayneL]

MRC,

I enter the trade with the total margin required (prem margin on market + risk margin) which they calculate using the asx margin estimator. In addition to this they ask for 100&#37; of the calculated figure as the overall total margin they hold, which means those funds are frozen till the position is closed. Ofcourse, the figure would obviously change as the market does each day, thus adjusting my overall total margin required at the end of each trading day. :(

If any option traders out there use a provider that requires less margin, let me know.

If you trade US option and have enough capital,or, trade futures option, many brokers will put you on SPAN risk margining.

It's a very cool way of margining as you can even go the synthetic route on the same margin (say a synthetically equivalent collar).

I wrote up some time ago on the topic http://sigmaoptions.blogspot.com/2007/01/new-margin-rules-for-option-positions.html

[Grinder]

Thanks Wayne,

Sounds ideal, will check it out when or if I start trading US options.:cool:

[chops_a_must]

Wayne... I'm seeking some advice on a potential strategy - put bull spread.

Just wanting to know your opinions on them, especially if looking to have stock put to you.

I'm looking at a trade atm that I feel could be set up. Buying a lower put at a strike which if passed, would signal a breakdown and a no no. (The natural gas ETF UNG happens to be what I am looking at.)

But having the written put at a number of strikes higher than the lower put, rather than the next one.

The maximum loss being at the point of lower strike price, correct?

Also... should you leg into this trade if the premiums aren't at acceptable levels at one time or other?

As an aside, what are the full brokerage fees for IB from opening to exercise? And can you hedge somehow so that the actual value of the trade, stays at the value of the opening of the trade in currency terms?

[wayneL]

Wayne... I'm seeking some advice on a potential strategy - put bull spread.

Just wanting to know your opinions on them, especially if looking to have stock put to you.

I'm looking at a trade atm that I feel could be set up. Buying a lower put at a strike which if passed, would signal a breakdown and a no no. (The natural gas ETF UNG happens to be what I am looking at.)

But having the written put at a number of strikes higher than the lower put, rather than the next one.

The maximum loss being at the point of lower strike price, correct?

As an aside, what are the full brokerage fees for IB from opening to exercise? And can you hedge somehow so that the actual value of the trade, stays at the value of the opening of the trade in currency terms?

OK what you have is a credit spread. The maximum loss is the width of the spread, minus the credit you received when you opened the strategy.

So for eg if the spread between the strikes is $5.00 and you receive $1.00 credit when you opened it, then the maximum loss is $4.00. Multiply by 100 and your risk is $400 per spread.

You can hedge your currency risk by going into idealpro and buying back the Aussie dollars you used for the trade at a rate of $500 per spread in the above example.

Hmmm, but minimum on idealpro is $25k or something.... maybe another forex broker... buts thats the idea anyway.

Regarding total brokerage. Have only been assigned once, yonks ago and can't remember the total... It's cheap as anyway with IB.

If you're particularly looking to be assigned, why not just short the put straight out?

[chops_a_must]

If you're particularly looking to be assigned, why not just short the put straight out?

Because if it goes below the lower strike, I wouldn't want it. ;)

[wayneL]

Because if it goes below the lower strike, I wouldn't want it. ;)
:eek::eek: Fair enough.

[chops_a_must]

Let's say you are constructing an iron condor.

It wasn't you that brought down this bull with your "Iron Condors" was it?

http://i4.photobucket.com/albums/y148/staringbakwards/bazan11.jpg

http://i4.photobucket.com/albums/y148/staringbakwards/bullcondor.jpg

http://i4.photobucket.com/albums/y148/staringbakwards/condorbull.gif


Cotabambas is a poor hamlet isolated in a remote corner of the Peruvian Andes. Each year for centuries the men of the village at their peril have climbed high into the mountains to bait and capture an adult Andean Condor, the world's largest winged predator. The condor and a bull are the centerpieces of an ancient ritual now enshrined as the Fiesta de Yawar. The condor, representing the Incas, overpowers a bull, representing the conquistadors. The condor is strapped to the bull's back and the bull, lacerated by the condor's powerful talons and maddened with pain, races around the barricaded central plaza chased by taunting villagers.

You guys should stop calling yourselves bears, and start calling yourselves condors! ;)

[chops_a_must]

Wayne....

Coming into option expiry this week. My protective put is almost no chance to be in the money. What is your philosophy for dealing with this? Do you try and sell that?

My written put will probably finish just out of the money, or on it, for maximum profit, but would like the underlying to finish just below.

I'm considering writing a call above now, to maximise profit, and either way will have a better break even point with bigger maximum profit potential.

Anything I'm missing... or should be aware of?

[wayneL]

Wayne....

Coming into option expiry this week. My protective put is almost no chance to be in the money. What is your philosophy for dealing with this? Do you try and sell that?

My written put will probably finish just out of the money, or on it, for maximum profit, but would like the underlying to finish just below.

I'm considering writing a call above now, to maximise profit, and either way will have a better break even point with bigger maximum profit potential.

Anything I'm missing... or should be aware of?

You've got a bull put spread right? i.e. written put, plus bought put at lower price?

Re: selling the long put... anything can still happen - Murphy's law.

As to what to look out for; if you have a short option with the underlying trading at or near the strike price, you have "pin risk".

This means, that you don't know whether you will be assigned or not at expiry. As I recall you want the stock, so that might not be a drama for you.

If you write a call (or take any new trade), you introduce a new potential reward, but also a new risk. That's for you decide whether you like the new risk profile. (the same applies for selling the long put)

Generally speaking though, spread traders have a look at risk/reward on an ongoing basis, If a spread has near 100% profit with time left to expiry, you really only have risk, but not much reward from this point on.

Just a couple of things to think about.

Another theory of mine; Murhpy's Law was probably originally coined by an option trader. :p:

[chops_a_must]

You've got a bull put spread right? i.e. written put, plus bought put at lower price?

Re: selling the long put... anything can still happen - Murphy's law.

As to what to look out for; if you have a short option with the underlying trading at or near the strike price, you have "pin risk".

This means, that you don't know whether you will be assigned or not at expiry. As I recall you want the stock, so that might not be a drama for you.

If you write a call (or take any new trade), you introduce a new potential reward, but also a new risk. That's for you decide whether you like the new risk profile. (the same applies for selling the long put)

Generally speaking though, spread traders have a look at risk/reward on an ongoing basis, If a spread has near 100% profit with time left to expiry, you really only have risk, but not much reward from this point on.

Just a couple of things to think about.

Another theory of mine; Murhpy's Law was probably originally coined by an option trader. :p:

That's correct.

The risk of being without cover on the downside is perhaps outweighed by the better break even point. Because in my mind, the chances are higher of the underlying falling within my break even point and lower strike, than they would be of clearing the lower strike outright.

What I could set up, is a call bear spread as well, so that there effectively cannot be a loss on that trade when the premium from the put is taken into account.

[cutz]

Hi All,

To the active option traders out there, what are you favourite strategies and do you put them on at once or leg in over a few days ?
Also are there any preferences to index over stock options and vice versa.

P.S. please excuse my terminology, i'm pretty new to the scene.

Cheers,

Cutz.

[mazzatelli1000]

Hi All,

To the active option traders out there, what are you favourite strategies and do you put them on at once or leg in over a few days ?
Also are there any preferences to index over stock options and vice versa.

P.S. please excuse my terminology, i'm pretty new to the scene.

Cheers,

Cutz.

Hey Cutz,

Welcome to the scene

Your questions will have been answered in other threads --- look in particular for posts by WayneL, Magdoran and sails.

My "favourite" strategy depends on the market conditions at any one time and my projections - i.e. volatility, IV levels, skews, underlying direction, time, what risk I want to expose myself to e.g. vega or delta and gamma.

I prefer not to leg in, but sometimes due to liquidity issues, the only way to get in some positions is to do so.

Indexes are GENERALLY less proned to huge gaps like their equity counterparts, and hence more often are recommended for market neutral strategies.
So in that way index options are preferred over equity options for certain strategies.

Cheers

[cutz]

Thanks mazzatelli1000.

Another query i would like to put fwd,

Say you feel that the index has reached a bottom or close to it so you decide to write a couple of sort term index puts just out of the money,
4 weeks till expiry for example.

Would you protect your position with a further OTM bought put or alternatively don't buy a protective put but roll into the next month, next strike if the short puts become ITM due to an error in judging the index.

I am not seeking advice, just opinions as a have tried both methods without getting into trouble and i sometimes feel that i am paying a high price for having the protection of a bought put.


What are peoples thoughts on this.

Cheers,

Cutz.

[mazzatelli1000]

Thanks mazzatelli1000.

Another query i would like to put fwd,

Say you feel that the index has reached a bottom or close to it so you decide to write a couple of sort term index puts just out of the money,
4 weeks till expiry for example.

Would you protect your position with a further OTM bought put or alternatively don't buy a protective put but roll into the next month, next strike if the short puts become ITM due to an error in judging the index.

I am not seeking advice, just opinions as a have tried both methods without getting into trouble and i sometimes feel that i am paying a high price for having the protection of a bought put.


What are peoples thoughts on this.

Cheers,

Cutz.

Cutz
It depends on your risk tolerance

With some indexes, the futures are accessible all hours so it can be used to synthetically alter risk profiles, so some are comfortable being short naked premium on indexes whether it be calls or puts.

Others may put on the bull put spread and subscribe to the "insurance" policy school of thought - i.e. better to have losses limited in case that evil black swan decides to appear or as you mentioned - an error in judging the index.

Whatever you are comfortable with.

Me personally I like to keep MOST short premium strategies to the limited loss type.

[cutz]

Thanks again mazzatelli1000,

You mentioned synthetically altering risk profiles using futures, would an example of this be going short SPI futures + writing index puts ?

Cheers,

Cutz.

[mazzatelli1000]

Thanks again mazzatelli1000,

You mentioned synthetically altering risk profiles using futures, would an example of this be going short SPI futures + writing index puts ?

Cheers,

Cutz.

Cutz

Yes...that would be a synthetic short call, if your after that profile

[wayneL]

Just adding a few thoughts to the index short put vs index bull put spread question:

As discussed, the absolute loss is known with the bull put. In the event of a black swan, being naked short puts could be account destroying. However in 24 hour futures markets, you can have contingency orders in place to hedge you out with futures on your naked put if the market goes *poof* while you're sleeping.

But you are at risk of the platform/technology failing at the wrong time.

Advantage => bull put.

However, those long puts come at a price. Index options are skewed to the downside, so you will be paying up for the put hedge. You will need somewhere between 3 to 10 spreads to net the same dollars as a single naked put. Therefore your contest risk (bid/ask spread + commission) is 3 to 10 times higher. Very unpalatable when forced to adjust or close out.

Advantage => naked put

Then we have a look at the payoff diagram:

http://i34.tinypic.com/zkh2jo.jpg

The maximum loss of the spread at expiry is greater than the naked put until you get past a certain point. Considering that indicies will give you continuity of pricing 99.9% of the time, allowing for timely adjustments and or exits:

Advantage => naked put

Then we have the greeks and volatility.

The naked put is long theta and short vega gamma all the time. The bull put is likewise while OTM. However once the price passes below the breakeven point, these greeks flop over; short theta and long gamma and vega.

As indexes sell off, implied volatility increases. So if the index starts dumping on you, vega is going to hurt you a lot more with the naked put, but it will help you in the bull put once you're ITM.

However this help via vega, turns to hindrance as that short theta will be high, so action will be required if it doesn't look like going back OTM. (Don't hope here)

The long gamma will always be a positive if ITM, thats a plus when your losing.

Advantage => Mixed... depends on exact situation

So looking at the overall picture, there are pros and cons for each in "normal" trading. But what of the 10 sigma black swan event?

Survival is the key requisite for survival and that might resolutely sway the argument one way.

FWIW

[peter2]

Excellent post WayneL. :xyxthumbs

[mazzatelli1000]

But you are at risk of the platform/technology failing at the wrong time.
FWIW

WayneL is spot on..one often only thinks of risks relating to market variables and often neglect those relating to execution.

Also, but this should not be the main consideration, there is opportunity cost of leaving your money as margin for collateral, while it could be utilised for other purposes.

[wayneL]

WayneL is spot on..one often only thinks of risks relating to market variables and often neglect those relating to execution.

Also, but this should not be the main consideration, there is opportunity cost of leaving your money as margin for collateral, while it could be utilised for other purposes.

Yes, should have mentioned margin too.

This is an advantage of futures options and SPAN margining... none of this 15% of strike price nonsense for naked positions.

[cutz]

In light of current events and my level of experience the bull put spread appears to be the preferred strategy out of the two.

I am trying to get my head around what it is to be long/short Greeks.

Using Wayne's example “The naked put is long theta and short vega gamma all the time” I interpret this as an increase in theta and decrease in vega gamma as advantageous to the position, if the position is a bought put would you say that you are short theta and long vega gamma ? , as the opposite is true.

Therefore does being long Greeks mean a positive move in the particular Greek advantageous to the total position and being short Greeks mean a negative move in the particular Greek advantageous to the total position.

Please steer me in the right direction if this is not correct.

Thanks Guys,

Cutz.

[mazzatelli1000]

In light of current events and my level of experience the bull put spread appears to be the preferred strategy out of the two.

I am trying to get my head around what it is to be long/short Greeks.

Using Wayne's example “The naked put is long theta and short vega gamma all the time” I interpret this as an increase in theta and decrease in vega gamma as advantageous to the position, if the position is a bought put would you say that you are short theta and long vega gamma ? , as the opposite is true.

Therefore does being long Greeks mean a positive move in the particular Greek advantageous to the total position and being short Greeks mean a negative move in the particular Greek advantageous to the total position.

Please steer me in the right direction if this is not correct.

Thanks Guys,

Cutz.

Im not sure what exactly your saying

But if your saying that say the naked put is short/negative gamma, and a more negative move will make it advantageous would not be accurate

[wayneL]

In light of current events and my level of experience the bull put spread appears to be the preferred strategy out of the two.

I am trying to get my head around what it is to be long/short Greeks.

Using Wayne's example “The naked put is long theta and short vega gamma all the time” I interpret this as an increase in theta and decrease in vega gamma as advantageous to the position, if the position is a bought put would you say that you are short theta and long vega gamma ? , as the opposite is true.

Therefore does being long Greeks mean a positive move in the particular Greek advantageous to the total position and being short Greeks mean a negative move in the particular Greek advantageous to the total position.

Please steer me in the right direction if this is not correct.

Thanks Guys,

Cutz.

Not necessarily. Long and short mean slightly different thing when we talk about greeks.

Substitute long for + and short for - and that should help you understand the context.

Therefore long gamma is +gamma (or positive gamma). We don't necessarily benefit from an increase in gamma, but we benefit from being positive gamma.

Same with theta. Id we're -theta (short) it's working against us, but a decrease in theta might not necessarily be in our favour (e.g. we might have just had a volatility crush).

Vega is a bit different again, if you're long vega and increase will probably be most welcome.

(and visa versa on each example of course)

That should have totally confused you. :)

[mazzatelli1000]

That should have totally confused you. :)

Cutz, it would be better to understand what each Greek is trying to convey in terms of risk for each position.

Fire up Hoadleys or something similar and observe those 3D Greeks.
Then tamper with the parameters and observe the changes.

Should mess your mind up even more:D

[wayneL]

Cutz, it would be better to understand what each Greek is trying to convey in terms of risk for each position.

Fire up Hoadleys or something similar and observe those 3D Greeks.
Then tamper with the parameters and observe the changes.

Should mess your mind up even more:D
Indeed :D

...and agreed. :)

[cutz]

Thanks Wayne,

Substituting Short with –, and Long with + has cleared it up.

Do you guys use the full version of Hoadleys Strategy Tool; I notice it’s been mentioned several times on this site.

Regarding index options, I currently dabble in XJO index options, but I was curious to know whether there are many differences in the dynamics between XJO and SPI options, ( apart from contract specs. of course).
I assumed there would have been higher turnover in the SPI options but looking at the SFE website depth page quotes are far and few between.


Cutz.

[wayneL]

I use the full version because I look at position greeks and do a lot of delta hedging, which you can't do with the free version (without a lot of number crunching)

[cutz]

Hi,

I have been playing around with the Hoadleys Strategy Tool but I am having a little bit of trouble with the Greeks, I will start with delta which is easiest to understand.

Using a BHP sep08 42.00 short call by 4 contracts @ $0.915 set up today, (example only), delta is 0.31. Reading the payoff diagram along the right edge, position delta reads -1300 at $38.8 (approx today’s closing price), does this mean the position will lose $1300 for every $1 increase in underlying ? Also what does (ESP) stand for on the position delta axis?

Position theta makes sense, it peaks ATM,

Position vega also seems to make sense peaking out ATM ($200 loss per 1% increase in underlying volatility.)

Position gamma peaks out ATM which reads off at -300 on the position axis, I can’t seem to get my head around this one, as the theoretical price calculator on my brokers site shows gamma 0.001.

Sorry guys,
I realize time has already been spent on Greeks, just trying to tie it in with the Strategy Tool.

Last of all, does the full version of Hoadleys Strategy Tool download prices and historical underlying volatility off free sites or does it require a data vendor for the volatility.

Cutz.

[elbee]

Cutz,

Yes the position described will at the moment lose about $1300 for a $1 increase in the underlying - delta of about .31 x postion size of 4 X 1000 unit size.

ESP is equivalent share position - ie. the option position is the equivalent (at the moment) of holding approx. 1300 shares.

The Hoadley tool can download option chains from free providers (including ASX delayed) and historical underlying prices for volatility calculations from Yahoo.

[cutz]

Hi Guys,

RE post #166.

It has finally clicked, looking at the chart, position delta reads -1300 at $38.8, and position gamma reads approx -280 therefore if underlying stock moves to $39.8 new position delta will -1300+ -280 = -1580.

Could someone please explain the thin blue curved line on the chart, my brain has locked up again.

Thanks,

Cutz.

[elbee]

If you mean the Hoadley Strategy Payoff chart then the thin blue line is the Profit or loss at the current time. The thicker darker blue line is the profit or loss at expiration.

Press the "cycle time to expiry" button at the top right of the sheet to see how these converge over time.

[cutz]

If you mean the Hoadley Strategy Payoff chart then the thin blue line is the Profit or loss at the current time.

Of course,

Thanks elbee.

Finally all pieces on the trial version have gelled, now to move onto the full version.

Cutz .

[cutz]

Hi Guys,

On the subject of Greeks, I have come to the realization that maybe I have been neglecting this area, for instance my main strategy has been short calls and short puts several strikes OTM near expiry on several stocks that I am familiar with, I will try to set up those trades around areas of support/resistance but my only consideration so far has been delta and to a certain extent theta, which give me an indication on the likelihood of exercise on stocks I have held for a long term which I want to avoid.

I have started shorting index options but I normally back these up with further OTM bought positions.

My question is how long do you guys spends analyzing Greeks before putting on a trade, is it just as critical with the simple trades I have described or are the Greeks more relevant for complex strategies.

Cutz.

[wayneL]

Hi Guys,

On the subject of Greeks, I have come to the realization that maybe I have been neglecting this area, for instance my main strategy has been short calls and short puts several strikes OTM near expiry on several stocks that I am familiar with, I will try to set up those trades around areas of support/resistance but my only consideration so far has been delta and to a certain extent theta, which give me an indication on the likelihood of exercise on stocks I have held for a long term which I want to avoid.

I have started shorting index options but I normally back these up with further OTM bought positions.

My question is how long do you guys spends analyzing Greeks before putting on a trade, is it just as critical with the simple trades I have described or are the Greeks more relevant for complex strategies, and what else should I be looking at for the strategies I have described ?

Cutz.
I a lot of delta neutral trades over the index (SP500) and some long gamma scalping on stocks when the planet are in line.

To me the greeks are paramount, particularly gamma and vega.

For instance if I sell an iron condor over the index, I want to know how much gamma and vega can hurt me. If IV is low, strikes will be closer, gamma will be higher and I am at significant vega risk if the index starts ploughing lower.

I like to delta hedge very frequently, and how I do that will be decided by the greeks and my volatility forecast. Also I want to hedge that vega, because that will hurt if IV takes off. I might do this by superimposing calendar spreads over the top of the condor, or I might use double diagonals instead.

And there is a big tip in that - Know how volatility changes are going to affect the greeks.

At times I might want to start adding delta and take a directional bias to some degree.

In other words, rarely will I have an off the shelf strategy in place.

It's a bit hard to consider everything when you're fairly new, but it is definitely the way folks should be thinking.

[mazzatelli1000]

My question is how long do you guys spends analyzing Greeks before putting on a trade, is it just as critical with the simple trades I have described or are the Greeks more relevant for complex strategies.
Cutz.

How long analysing?
As long as you feel comfortable you understand the risks you are exposing yourself to.

Is it critical only for complex strategies
It is just as critical for these "simple" trades as it develops analytical skills and these simple trades are often building blocks for "complex strategies".

When I first began trading options, I spent time analysing how the Greeks worked for each particular off the shelf strategy e.g. credit spreads, butterflies, DD, IC, but after a while you will just know that for instance Condors are negative gamma, long theta and short vega.

After this stage of focusing on individual trades - I found myself with a portfolio of trades e.g. Condors overlapped with Calendars and which sometimes included stocks and futures as well. I started to contradict myself about what was making money and what was not, and what "net" risks I was exposing myself to. :banghead:

So analysing the Greeks on a portfolio basis and being able to quantify the amount of delta (for delta hedging), will help.

So basically, you CANT SKIP THE GREEKS...:mad:

I am a mean bast**d for suggesting this, but you should also learn how to dissect positions - which is covered by an author by the name of Charles Cottle. :D

This will keep you thoroughly confused for months to come :)

[cutz]

Hi guys, thanks for your inputs on Greeks.

Quick question on volatility,

Entering historic volatility into the modeling tool along with the contract specs gives us a theoretical value on the contract, entering last trade price in price override and hitting calculate implied volatility gives us implied volatility, obviously traders are bidding contract prices up or down which in turn drives imp vol depending whether they are feeling bearish/bullish on underling.

But from what I have been reading option prices are valued based on future imp vol therefore the above calculation is done in reverse, implied volatility first then theoretical value calculation is made, so if theoretical price does not match up with market prices the trade is not done.

Is this how you guys come up with an option value and how would you come up with future volatility, is a judgment call made using charted imp vol history? If this is the case what sort of software do you guys find useful to track the Aussie imp vol?

Cutz.

[mazzatelli1000]

Is this how you guys come up with an option value and how would you come up with future volatility, is a judgment call made using charted imp vol history? If this is the case what sort of software do you guys find useful to track the Aussie imp vol?

Cutz.

Firstly cutz - i recommend you trawl through these forums as many of these questions have come up and been discussed at length!!

Option Value - pretty much - Black Scholes model has all its variables you need to input to spit out an option value.

Implied volatility which looks forward, is extracted from theoretical price by rearrnaging the Black Scholes formula.

It is very subjective IV. Yes you can look at past IV and find a period which closely correlates to current conditions now to try and forecast volatility movements.

You can also watch how HV and IV move in relation to each other to try and forecast IV and the magnitude of movement.

You can also watch how IV and HV reacts to stock price to make assessments again. As WayneL alluded to before, often stocks and indices, when they start ploughing lower, IV tends to increase but not always and not for every stock/index/ETF.

Also be aware that volatility (HV or IV) in the long run tends to mean revert.

With regards to Aussie IV, i dont trade Aussie options so can't help a great deal.

There is www.ivolatility.com.au - heard good things

Also premiumdata.net has IV as an indicator option which can be imported into AmiBroker and MetaStock programs to make the appropriate analysis.

But that is all i know.
This has come up in other threads if i recall correctly, look for posts by sails.

Cheers :)

[fimmwolf]

There is www.ivolatility.com.au - heard good things

Just wondering, should this URL be: http://www.impliedvolatility.com.au/

[mazzatelli1000]

Just wondering, should this URL be: http://www.impliedvolatility.com.au/

Yeah, i shouldn't be so lazy with my posts.
Apologies people

[cutz]

Hi All,

I have a synthetic long on at the moment, the underlying stock is going ex div. tomorrow, the long call leg of the position is in the money with only intrinsic value in its price, will I expect to see a drop in the value of the call by the amount of the dividend tomorrow ? Or has the dividend loss already been priced into the call, I didn’t expect to be holding a position through it ex div. I overlooked that aspect when I put on the trade.(another lesson learnt):)

Thanks,

Cutz

[elbee]

The option price will already have the dividend factored in.

[cutz]

Thanks for the reply elbee,

So the following should happen, stock price should drop, call should remain stable therefore losing some intrinsic value and picking up some time value,

I guess a couple of clues should have pointed me to the fact that the underlying was going ex div, the fact that an ATM call was trading with intrinsic value only with a month remaining, I thought that was quite strange,but didn't look into why.

When I set up the position a couple of weeks ago I punched the figures into Hoadley’s, the short put leg was showing an IV of 85% and the long call was showing an IV of 37%, I was quite chuffed at this thinking I scored the call on the cheap but looking back it was trying to tell me something else, (i.e. ex div shortly):o

cutz.

[chops_a_must]

I'm not so sure.

If the option only has intrinsic value left in it, can't you be exercised at the end of the day, and have the dividend stripped?

I'd be looking at closing the position at the end of the day... but that's just me, and I'm not totally sure about this...

[cutz]

Check out ANZ6B, you will see what i mean, give or take a few cents,:)

cutz.

[sails]

Thanks for the reply elbee,

So the following should happen, stock price should drop, call should remain stable therefore losing some intrinsic value and picking up some time value,

I guess a couple of clues should have pointed me to the fact that the underlying was going ex div, the fact that an ATM call was trading with intrinsic value only with a month remaining, I thought that was quite strange,but didn't look into why.

When I set up the position a couple of weeks ago I punched the figures into Hoadley’s, the short put leg was showing an IV of 85% and the long call was showing an IV of 37%, I was quite chuffed at this thinking I scored the call on the cheap but looking back it was trying to tell me something else, (i.e. ex div shortly):o

cutz.

Looks like you have it sorted, Cutz :). Yep, cheap calls and expensive puts are a clue to dividends coming up. Such a large IV differential between puts and calls certainly gives it away. Once the dividend is entered into Hoadley, it gives a different picture. Box trades look like a risk free trade to the unwary prior to dividends - but the risks lurk in the dividend and potential assignment.

Depending on the rest of your position, you could consider exercising your long call before close today and pick up the dividend (and possibly the franking credit depending on your circumstances) - but would then have to be willing to take the downside risk on the shares. Also, need to know your brokers fee structure on exercised options as it may not be worth the effort. As you probably know, no use trying to hedge with a close-to-the-money put as the dividend is priced into the put.

Also, if you have WebIress, click on the Analytics tab, then Option Valuation. In the middle section, you can change the volatility, move Todays Date backwards and forwards. Underlying Price can also be changed, but when the market is trading it keeps defaulting to the current price. Changing price is easier to play with when the market is closed. Anyway, when the changes are made, the option value changes in the top left hand box "Value". It's a quick way to get an approximate price - although I feel Hoadley is still more reliable overall.

[sails]

I'm not so sure.

If the option only has intrinsic value left in it, can't you be exercised at the end of the day, and have the dividend stripped?

I'd be looking at closing the position at the end of the day... but that's just me, and I'm not totally sure about this...

Chops, not if it is a long call - he stays in control of exercise until expiry day when most brokers automatically exercise all ITM long options.

[cutz]

Thanks for all your inputs guys,

I decided to close out the position and take the profits off the table, I felt a little uncomfortable holding a position through it ex dividend, I will observe from the sidelines to see what happens to it tomorrow.

Sails, thanks for the tips, very helpful as always.:)

Unfortunately comsec charges 0.35% on assignment/exercise, I learned the hard way with covered calls on CSL some time ago, I was slapped with assignment and a hefty brokerage bill and a valuable lesson on covered calls:banghead:

cutz

[sails]

With ANZ going xdiv tomorrow and NAB the next day, it's probably a timely reminder for anyone with in-the-money short calls to consider closing out before xdiv day. There is a high risk of being assigned later today (ANZ) and only find out about it tomorrow morning. This means that as a short stock holder one is liable to pay the dividends :eek:

Even if in a bull call spread, the long calls don't offer any real protection from having to pay the dividend. If in a bull call spread where both strikes are in-the-money, it usually pays to either close both out the day before OR exercise the long calls which means one is long stock on xdiv day and will receive the dividend. By exercising the long call and being assigned on the short closes the position and neutralises the dividend. BUT check your brokers fees on exercise/assignment - could make a difference to how this is handles...

One catch to the above is if for some unusual reason the short calls aren't assigned - then one would be long stock the next day and is no longer the limited risk position offered by the original bull call spread.

I normally use the rule of thumb that if both strikes are both deeply in-the-money, it is probably OK to assume assignment of the short call. If they are closer to the money and if there is still a fair bit of time value, then may be best to simply close out.

Hoadley's OSET has a tab for for working out the probability of early exercise. Make sure imputs include correct dividend amount and date, IV, etc, etc. Useful as a guide, but personally, I usually like to ensure a bit extra as a buffer.

[sails]

Thanks for all your inputs guys,

I decided to close out the position and take the profits off the table, I felt a little uncomfortable holding a position through it ex dividend, I will observe from the sidelines to see what happens to it tomorrow.

Sails, thanks for the tips, very helpful as always.:)

Unfortunately comsec charges 0.35% on assignment/exercise, I learned the hard way with covered calls on CSL some time ago, I was slapped with assignment and a hefty brokerage bill and a valuable lesson on covered calls:banghead:

cutz

Congratulations on a profitable trade, Cutz :) A wise thing to do IMHO and you will most likely learn as much as if you were still in the position as you have had real money in that trade. There will be many more opportunities down the track...

I was with AOT when Commsec bought them out. I didn't stick around with Commsec because of that wicked .35% - AOTonline used to charge a flat rate of $30 for assignment - massive difference! I wrote to them explaining that if I had a narrow bull call spread on a high priced stock, it would cost more in fees than the max profit in the spread. But they were not interested - I guess just happy to fleece any newbies that come along...

[cutz]

Thanks Sails,

I keep promising myself that I have to change brokers, just got to get outside my comfort zone of dealing with an Australian firm.

[sails]

Thanks Sails,

I keep promising myself that I have to change brokers, just got to get outside my comfort zone of dealing with an Australian firm.

Cutz, I tried IB, but found their platform very confusing with Oz options and their customer service didn't seem to know much about Oz options either. Maybe I was too quick to give them a go before they got everything up and running properly. They didn't have any greeks available for Oz options at that time.

I currently use an Aussie broker Trader Dealer (Rob is the options broker to talk to there - although he goes on holidays soon for a about three weeks) and also have an account with OX as a backup. OX has the better fees if on frequent trader status, but it is nice to have someone pick up the phone straightaway with TD in the rare event it is required. OX would often just take my name and number and get a broker to call back. Too bad if it was urgent - like trying to close a trade and losing profits coz their platform has a glitch!

TD exercise fees are same as their stock fees and I'm on a good rate with them but it's still a bit expensive when compared to OX. But then OX doesn't have WebIress and I don't think I could Oz trade options without it now. I usually do enough trades each month so I don't pay extra for WI. So, if it's any help, that's the pros and cons with the two I use. :2twocents

[cutz]

Yep,

I use Webiress with comsec and its quite good, so at this stage I’m leaning towards setting up an account with OX and also keeping comsec up and running just so I could still use Iress to push through trades that don’t run the risk of assignment.

I like the look of IBs Traderworkstation with all the Greeks and put/calls nicely laid out on one screen but a poster put up a question on why the Greeks weren’t showing and I’m not sure how he went, also as you pointed out its nice to be able to pick up the phone and get through to someone who knows what’s going on.:)

Cutz.

[Grinder]

How can we get the best of everything? like the way it is in the US, with a broker like TOS all in one. Any ideas?

With commsec for their customer service which is always good for ops & free pro trader 2 (pissing me off lately though) but the excuberant fees compared to OX deters me. Mostly trade through OX eventhough they seem to have only 2 guys working the desk, who are never their, and without the greeks it makes it tough, so have impliedvolatilitytracker site with hoadleys to assist. Spoke with IB, but it was like pulling teeth to get basic questions answered.

Now that I've had a whinge and trashed everyone, feel much better, but still in same predicament. Is traderdealer the answer Sails? I remmember there was some drama after opes prime went down.

[mazzatelli1000]

How can we get the best of everything? like the way it is in the US, with a broker like TOS all in one. Any ideas?

With commsec for their customer service which is always good for ops & free pro trader 2 (pissing me off lately though) but the excuberant fees compared to OX deters me. Mostly trade through OX eventhough they seem to have only 2 guys working the desk, who are never their, and without the greeks it makes it tough, so have impliedvolatilitytracker site with hoadleys to assist. Spoke with IB, but it was like pulling teeth to get basic questions answered.

Now that I've had a whinge and trashed everyone, feel much better, but still in same predicament. Is traderdealer the answer Sails? I remmember there was some drama after opes prime went down.

Ahhhhh all the same reasons that led me to trade options in the US and give up on Oz

IB was never a broker to be obtaining help from like TOS. Low cost, learn to use it yourself sort of broker.

OX is terrible - they got a few Customer Rep guys whose job it seems is to answer all your questions in one sentence

[sails]

How can we get the best of everything? like the way it is in the US, with a broker like TOS all in one. Any ideas?

With commsec for their customer service which is always good for ops & free pro trader 2 (pissing me off lately though) but the excuberant fees compared to OX deters me. Mostly trade through OX eventhough they seem to have only 2 guys working the desk, who are never their, and without the greeks it makes it tough, so have impliedvolatilitytracker site with hoadleys to assist. Spoke with IB, but it was like pulling teeth to get basic questions answered.

Now that I've had a whinge and trashed everyone, feel much better, but still in same predicament. Is traderdealer the answer Sails? I remmember there was some drama after opes prime went down.

Oh yes, if only we could have the best of everything for Oz options - but realised is probably not going to happen for a long time yet. Oz markets are probably just too small.

Yes, I found IB customer service very difficult. They tried hard to help, but it was frustrating on my part. They only seemed to have their general customer service people available during Oz trading hours - couldn't get the specialist people who are probably only available during US trading hours.

I don't know if TraderDealer is for everyone - works for me, but no bells and whistles either - just excellent customer service. If WebIress ever get round to adding the ability to enter option spreads on line (even two legs as OX already do), it would make it much easier. At this stage I email option spread orders to TD - they could also be phoned. Once they enter it into the system, they give me the code for that combo, and then I control that order myself eg. can amend price, amend quantity, delete and re-enter later if I want to as I would for any other order. One of the cool things is that you can then bring up a market depth window to see if anyone else is trading that same spread.

TD was bought out by MDS finance after the Opes Prime debacle - hopefully MDS are doing OK! Funds are held in a bank CMT, so they should be OK.

I would much prefer to trade US options due to all the benefits of trading with TOS and the cheaper fees, however, present circumstances have made it almost impossible to work at night and sleep in the day, so I'm stuck with the Oz market at the moment and I personally feel TD is the best around for my needs anyway. :2twocents

[Grinder]

Thanks for your insight Sails, will continue to push on with my predicament and debate the pros & cons of each broker till I eventually convert to the US.

[sails]

Thanks for your insight Sails, will continue to push on with my predicament and debate the pros & cons of each broker till I eventually convert to the US.

Yes, it's a trade-off what ever we do. Trade the US and put up with sleepless nights and the effects that has on lifestyle OR put up with the difficulties in the Oz market and attempt to keep fees under control.

All the best with your deliberations... :)

[cutz]

I’m with you sails, aussie options during the day. I don’t think I could handle the nightshift; I probably fall asleep in front of my computer.

I am interested to here from the guys and girls who trade through the night and how those sorts of hours are handled.

[mazzatelli1000]

I’m with you sails, aussie options during the day. I don’t think I could handle the nightshift; I probably fall asleep in front of my computer.

I am interested to here from the guys and girls who trade through the night and how those sorts of hours are handled.

The nightshift defnitely has its challenges, but considering the timeframe of the option spreads I utilise, I feel it does not require me to sit in front of my computer all night.

I usually wake up 4:30a.m. for my daily exercise and so will have a look at how the US market is panning out and make any trades if my entry criteria is satisified, as usually around this time it is the afternoon session of trading.

Also, before I goto bed I will look at the index futures before open and assess whether I will need to stay up to manage etc.

So there are grudge days where you will feel extremely tired, but it is not every single day.

I have had to give up intra day trades on the /YM as I simply cannot stay awake all night.

Always been considering the Hong Kong, Singapore and Korean markets, but I dont know much about them and data is not readily available like US.

[Grinder]

Always been considering the Hong Kong, Singapore and Korean markets, but I dont know much about them and data is not readily available like US.

Same. Spoke to a rep at IB about Kospi ops, was'nt able to get much relevant info though.

[cutz]

Hi all,


Does anybody have any use for those 1point strike price options, is it some
sort of quasi futures type contract ? or am I way off the mark. What I am looking at the moment on the screen is XJO1O, the Nov call which has an open interest of 203, only 20 contracts were traded last Friday and 1 last Thursday, it doesn’t seem to be very liquid so I was curious on wide the spreads on offer would be and if they would closely resemble the ASX200 index at the time the spread was requested.

Thanks in advance.

[sails]

Hi Cutz - check out this page on the ASX site :) http://www.asx.com.au/products/options/lepos.htm

[cutz]

Thanks Sails,

Yeah, it looks like it may behave like a futures contract, I will be interested to see what the spreads are like.

[sails]

Yes, check them out - hopefully they have improved. It was a long time ago since I looked into them and the spreads were pretty wide.

Barrier warrants also move a lot like futures with smaller spreads - especially if the SPC is 1. Worth looking at, but wouldn't rush in until it's properly understood with all the associated risks. Citibank seem to be the main ones providing the barrier warrant series - and I'm not sure about their reputation. If you're interested, I will spell out what I know about them...

[Reealjrd]

Well Friends,

Trading in commodities futures market is a very good idea. Well trading in futures and options is risky but good too.

[mazzatelli1000]

Well Friends,

Trading in commodities futures market is a very good idea. Well trading in futures and options is risky but good too.

Options were designed to minimize risk.

It's only risky in the hands of the wrong person ;)

[cutz]

Well Friends,

Trading in commodities futures market is a very good idea. Well trading in futures and options is risky but good too.

Yeah, i dunno about that, i have found shares to be a lot more risky than options.

[cbacamden]

Agree 100% about the risk ! Options, warrents etc are only risky if you get greedy, carless or forget the high leverage and time decay.

I personaly love Warrent Minis - Again, the only time I have got in trouble is when i have been been greedy (ie: not stuck to the rules)

[cutz]

Hi all,

I set up a short index strangle last month but recent events has caused the put leg to turn against me , therefore today with 2 days to go I rolled the put into December with a strike 4 levels down.

I thought about letting the losing trade cash settle on Thursday and set up another short put position on the same day but I decided to roll into the next month today, I sort of feel this could be a case of 6 or ½ dozen the other, any thoughts on this, i.e. should I have waited till expiry as this is a cash settled series.

I’m prepared to cop a bit of flak here as it looks like I’m fighting against the market trend but I do feel a minor bounce could be coming and I do want to take advantage of high IV.

BTW, I’m not after advice, just opinion on how the experienced would have handled this.

Thanks in advance.

Cutz.:)

[sails]

Hi Cutz - I have no experience in uncovered short positions, so hopefully someone else can help here. Any short option trades for me are always covered with a long option somewhere - I like to sleep at night :)

Theoretically though and with IV so high, I am guessing you have sold a reasonably fat premium further OTM in December.

I think you would need a crystal ball to know if it was better to roll now or at expiry as it will depend largely on what the index does between now and then. Hopefully someone else with more experience in this strategy can help...

[cutz]

Theoretically though and with IV so high, I am guessing you have sold a reasonably fat premium further OTM in December.


Hi Sails

Yes that's the case, the Nov was trading with intrinsic value only and the Dec had a good serve of time value due to the high IV.

Late Note, Actually Sails i went from Deep ITM to ITM

[sails]

...
Late Note, Actually Sails i went from Deep ITM to ITM

Just as well it's an index trade - otherwise the short put would have been high risk for assignment!

Are you rolling your calls down as well to bring in a bit more premium? Even so, would have to take care how far they are rolled down as you don't want to have the call side going against you if the market decides to take a breather.

From what I have read of others doing these types of trades is to roll the short option down & out (for puts - up & out for calls in a rising market) at some point where it can be done for even or a credit. I would imagine this would need to be done well before it is ITM especially for a strangle. Not much help for this situation, but maybe something to backtest for future trades :)

[cutz]

Hi All,

Yeah Sails just as well it was an index option:o, although I do have protective longs in place on stock options 95% of the time.

Here’s the trade that went pear shaped for whoever is interested, perhaps a lesson on not what to do, feel free to comment or criticise.

Initially when I set up the short strangle in early oct. XJO seemed to have some support at 4000, IV was high, so I set up the short put OTM leg. Over the next few days XJO rallied IV was still high I then set up the short call OTM leg. I’ve done this type of trade many times before with success so I guess I was I bit sloppy.

But as it turned out 4000 didn’t hold so I had to take some defensive action which I left a little late.

A few lessons I will take from this trade are, (1) Have a protective long on the down side in place even though it is an index option, (2) close out the leg that’s showing a profit rather than wait for expiration and risk giving your profits back especially in these volatile conditions, I did have that opportunity on the short put but I chose to hang on, (3) The short call leg will expire worthless but I should have closed it out and rolled down a couple of notches.

[mazzatelli1000]

Initially when I set up the short strangle in early oct. XJO seemed to have some support at 4000, IV was high, so I set up the short put OTM leg. Over the next few days XJO rallied IV was still high I then set up the short call OTM leg. I’ve done this type of trade many times before with success so I guess I was I bit sloppy.

But as it turned out 4000 didn’t hold so I had to take some defensive action which I left a little late.

A few lessons I will take from this trade are, (1) Have a protective long on the down side in place even though it is an index option, (2) close out the leg that’s showing a profit rather than wait for expiration and risk giving your profits back especially in these volatile conditions, I did have that opportunity on the short put but I chose to hang on, (3) The short call leg will expire worthless but I should have closed it out and rolled down a couple of notches.

Cutz,
I have had near heart attacks and seizures from putting short strangles on in the past :eek:

As sails has outlined you should roll down the call to beef up the premium. I have in the past created a straddle at my break even point, but only because I believe the underlying was stabilising there --- so in this example I am still rolling down a call, but all the way to my short put strike - creating the short straddle. But one must consider collateral requirements and the risk the underlying could reverse.

Better to have the "wings" :D

The other thing is to tighten your breakevens as it gets closer to expiration and lock in the profits

Theoretically you can try to keep the position delta neutral - but the collateral and commissions might be too much.

That is as far as my experience with short strangles.
Sorry I can't be any more help.:o

[Grinder]

Hey Cutz,

Your fairly brave to initiate anything uncovered in the present market climate, or even anytime. The strangle was'nt a bad idea and it sounds like you had a plan initially, don't know if I would have played it much different. Would have probably adjusted and taken smaller profits earlier when the market was giving them out, but thats just my comfort level. Sounds like you know what you should have done.

[cutz]

Thanks for your inputs guys,

Yeah I had a plan to start but I guess in the attempt to squeeze every bit of theta out of the position I got bitten, classic case of greed bias. I agree with you Grinder, in hindsight I would have closed out early, I have done this many times before on stocks options and the index but for some reason I was convinced there was going to be a bounce on the index. Every now and again I try to predict the market with little success so I should really stick to directional neutral strategies.

Mazza, what’s meant by the term “tighten your breakeven” and how would you implement it in a strangle?

[sails]

...A few lessons I will take from this trade are, (1) Have a protective long on the down side in place even though it is an index option, (2) close out the leg that’s showing a profit rather than wait for expiration and risk giving your profits back especially in these volatile conditions, I did have that opportunity on the short put but I chose to hang on, (3) The short call leg will expire worthless but I should have closed it out and rolled down a couple of notches.

It's a shame that the best lessons are usually learned painfully where in "hindsight" it is clear what we should have done. I have had many such lessons :(

I think your idea of adding a protective long in future on the down side makes a lot of sense volatility wise. IV usually rises as the market falls which we know hurts short options, so that protective long would not only hedge downside directionally, but also help to hedge against rising IV. The thing against could be the cost due to IV smile - but probably better to pay up and keep the risk under control. On the upside IV usually declines a bit, and this would help your overall strangle position together with timely defensive action.

You could still manage your short position as if there were no protective long - i.e. still roll down and out diagonally if the market looks like it's got more down to go.

Something else to look at now is the possibility of adding (or rolling) a short December call (but allowing enough room for the market to oscillate on the upside - if it can remember how :D). and perhaps using some of that premium to pay for a cheap OTM put. May be too far gone in the down trend to do so, but it might give you a little peace of mind which helps rational thinking (at least for me!).
Eg the 4000 Dec call would bring in around 43c at the moment (you might be happy to sell a lower strike and pick up more premium) and a Dec 2500 is currently bid at 15c (no ask though).

Also, if it keeps moving down, see if it's worthwhile to roll your short put down and out even further. For instance, December 3700 put bid/ask 334/363 - could be rolled to March 3400 for bid/ask 345/389. If these the two legs are ordered as a combo, it often saves a lot of slippage.

Anyway, not advice - just some ideas to think about. All the best with it :)

[cutz]

Hi Sails,

Yes I am in the process of setting up the dec call legs, I have pre-purchased the protective deep OTM calls to be on the ready, but I’m holding off on the shorts calls, I’m feeling a bit gun shy as I don’t want to be caught out in that overdue bounce. ;)

I tell you what; the market markers are being a bit cheeky.

[sails]

I tell you what; the market markers are being a bit cheeky.

Yeah, like I said somewhere recently - they're not into charity... :D

[jackson8]

hi guys
a question concerning margins
am writing covered calls over a stock i own osh but wish to now consider the synthetic stragety of selling otm naked puts over osh as well ......will receive premium and if sp falls below strike am quite happy to be assigned

if i sell 1 contract naked call at $4. strike sp now aprox $4.60 will i be required to lodge as cash colateral $4000 (1000x$4) or am i only required to fulfill a margin requirement of a lesser value depending how underlying sp behaves

with thanks gary

[sails]

hi guys
a question concerning margins
am writing covered calls over a stock i own osh but wish to now consider the synthetic stragety of selling otm naked puts over osh as well ......will receive premium and if sp falls below strike am quite happy to be assigned

if i sell 1 contract naked call at $4. strike sp now aprox $4.60 will i be required to lodge as cash colateral $4000 (1000x$4) or am i only required to fulfill a margin requirement of a lesser value depending how underlying sp behaves

with thanks gary

I think it varies between brokers - some want 100% cash cover for short puts - others are OK with varying degrees of margin. Best to check with your broker...

[cutz]

hi guys
a question concerning margins
am writing covered calls over a stock i own osh but wish to now consider the synthetic stragety of selling otm naked puts over osh as well ......will receive premium and if sp falls below strike am quite happy to be assigned

if i sell 1 contract naked call at $4. strike sp now aprox $4.60 will i be required to lodge as cash colateral $4000 (1000x$4) or am i only required to fulfill a margin requirement of a lesser value depending how underlying sp behaves

with thanks gary

Hello gary,

To work out your margin requirements assuming you’re with comsec go to this site http://www.asx.com.au/opc/OpcStart?Mode=M ,find your underlying then select your contract from the drop down box then hit go, a new screen will come up ,in the no of contracts field select no of positions, because it will be a short put make sure you put a minus on front of the number, when you’re done hit recalculate it will then show you risk margin, premium margin and total margin, to calculate margin that's required by comsec just double the total margin that is shown on the ASX site.

Cheers

cutz:)

[cutz]

Hi gary,

The list of stocks you can use as collateral is here http://www.asx.com.au/data/acceptable_stocks.pdf OSH is on the list and it gets a haircut of 30% but I don’t think you can lodge it as collateral as it may be reserved for your covered call, so unless you have other stocks available you will have to submit cash. Just a word of caution it always pays to have plenty of margin in the tank on short postions as running on the limit may have its dangers but i will leave that to the more experienced for further comment if req.

Cutz.:)

[jackson8]

have had first experience with margins today
have only been writing covered calls with the stock being held as colateral
so have not had to worry about margins

but just recently upgraded option account to level 4 which now allows sale of naked puts and calls ( calls im not interested in )

had a sms today saying had been rejected settlement of a margin on my sold call as no funds in my cash account and charged $54 for the trouble

seems that since the upgrade of options level the stock wont cover any large rises and margins may be called , has to do with the ability to now go naked .

have found it a bit confuseing so will just have to keep account topped up like you say cutz

what i find hard to beleive is that you only find out about margin call at beginning of each day yet there is no provision for me to be able to have instantaneous transfer of funds into there account .......think they would give you 24 hrs to transfer funds as most banks only transfer overnight

suppose its all a learning curve

thanks for your help guys

[cutz]

Hi Jackson8,

With a level 4 accounts you need to ring up comsec on their options line and request to lodge securities as collateral from your nominated HIN overwise they will start pulling cash from your bank account, I think this happens automatically on a covered call only account but not on a level 4 account, best ring them up to elaborate.

Your position statement will show your current margin level and what’s still available; I start to sweat when I approach 50%, any higher I begin closing out positions.

[KFC soup]

can you do spread on comsec?

[jackson8]

not that i am aware of

[jackson8]

just a comment concerning trading over internet versus phone

wanting to ring my options desk just to check on a couple of trades i had made over the internet

put on hold for all of twenty minutes so would hate to think the financial implications of wanting to close out a position which was going against you

[cutz]

Hi Jackson8

Are you using webiress with comsec, without it on days like today it would be like driving blind.

[jackson8]

Hi Jackson8

Are you using webiress with comsec, without it on days like today it would be like driving blind.

no not at this stage cutz .........am only writing calls over shares i own but am thinking of selling long dated otm puts.

do i need to be aware of implictions with puts stragety such as dividends or the like

thanks gary

[cutz]

Hi again,

Refer to Sails's posts #183 and #186 for div. implications, also can i suggest you sign up for webiress, at least for the free trial period, then if you are still happy to use it's free anyway if you do a small amount of trades per month.
BTW this doesn't mean i am happy with comsec, i feel i'm getting stitched up with brokerage costs but i am not changing brokers till this market mayhem has sorted itself out.
Also Options As A Strategic Investment is essential reading if you're looking at getting fired up in this game.:)

[cutz]

gary,

Be careful with covered calls if you have no intention of selling the underlying,
Manage the position to avoid assignment esp. with comsecs charges.
I learnt quickly the hard way with unwanted CGT implications and the trouble of buying back those stocks.

[mazzatelli1000]

Also Options As A Strategic Investment is essential reading if you're looking at getting fired up in this game.:)

Brings back memories ---gosh that was a dry read (but essential) ;)

[jackson8]

Hi again,

Refer to Sails's posts #183 and #186 for div. implications, also can i suggest you sign up for webiress, at least for the free trial period, then if you are still happy to use it's free anyway if you do a small amount of trades per month.
BTW this doesn't mean i am happy with comsec, i feel i'm getting stitched up with brokerage costs but i am not changing brokers till this market mayhem has sorted itself out.
Also Options As A Strategic Investment is essential reading if you're looking at getting fired up in this game.:)

i appreciate your help ..........

agree with your comments about comsec and i know there are cheaper brokers out there but feel secure useing them at this stage and the amount of paperwork to sign up elsewhere can be a bit daunting.

will check out posts mentioned above

thanks gary

[sails]

no not at this stage cutz .........am only writing calls over shares i own but am thinking of selling long dated otm puts.

do i need to be aware of implictions with puts stragety such as dividends or the like

thanks gary

I think I only mentioned short calls and dividends in earlier posts. Short puts do not carry the same dividend liability. It is most unlikely that a short put would be exercised the day before x-div as most will want to retain ownership of their shares to receive the dividend and would therefore wait until at least the day after before exercising their long puts. In fact, it it happened, you should be entitled the dividend as a bonus.

If your short puts are ITM in the days following Xdiv - there is a much higher level of being assigned as long stock holders have received their entitlement to the dividend and if there isn't much time value left in their ITM long puts (your short puts) - they are quite likely to exercise.

Short puts do have the advantage of being increased in price due to the impending dividend factored into them - which then dissipates after xdiv day.

Also, interest rates affect longer term options. A simple example is when buying a longer term call option, interest is pre-paid and is why calls are so much more expensive than puts as they have some reduction due to the interest rate component of their pricing. It is worthwhile, IMO, to fully understand these other forces which are at work in option pricing.

Anyway, all this is my :2twocents and only of the top of my head! Suggest you read some good option text books to confirm my ideas and make sure you understand how dividends are factored into option pricing.

[mazzatelli1000]

i appreciate your help ..........

agree with your comments about comsec and i know there are cheaper brokers out there but feel secure useing them at this stage and the amount of paperwork to sign up elsewhere can be a bit daunting.

will check out posts mentioned above

thanks gary

Not only are there cheaper options - but more efficient too, particularly concerning spreads etc. I know I have banged on about this before, but I cannot understand why people stick with Commsec. If one is treating this as a business, it would be extremely poor practice.

You can still keep Commsec for data purposes, but for execution defintely look somewhere else.

[cutz]

Hi all,

I want to run down a trade I just put through for comment,

I now normally set up put credit/call credit spreads depending on the market conditions at the time, with stock options I prefer to deal with underlying stocks I own as I feel like I know them well, I don’t want to assigned therefore that’s why I add wings to the short call, I know this may sound weird.

If the stock moves up through my lower strike I normally carry out a diagonal roll into the next month, if the stocks explodes through the lower strike the roll could end up being 2 months fwd which I don’t like to do and luckily this is a lot rarer, therefore I’m rolling so I don’t have to take a loss on the call spread and I don’t want to be assigned.

Today I put on a backspread i.e. I sold 4 calls and bought 8 calls with the strikes further apart, the calls I purchased cost the same as if I would have put on just a simple call credit spread (relatively), now I know this position is long Vega and IV on this particular stock is likely to decrease but the intent of this trade is to cover myself if the stocks keeps running up.

So the end result is I’ve obtained some good premium, (but it could have been much better because I stuffed this trade up), I feel this stock may continue running up but I’m not 100% on this.

If the stocks keeps running up follow up action may not be as painful.

Feel free to give me opinions on this, and don’t hold back on flack as i can take it.:D

[wayneL]

Hi all,

I want to run down a trade I just put through for comment,

I now normally set up put credit/call credit spreads depending on the market conditions at the time, with stock options I prefer to deal with underlying stocks I own as I feel like I know them well, I don’t want to assigned therefore that’s why I add wings to the short call, I know this may sound weird.

If the stock moves up through my lower strike I normally carry out a diagonal roll into the next month, if the stocks explodes through the lower strike the roll could end up being 2 months fwd which I don’t like to do and luckily this is a lot rarer, therefore I’m rolling so I don’t have to take a loss on the call spread and I don’t want to be assigned.

Today I put on a backspread i.e. I sold 4 calls and bought 8 calls with the strikes further apart, the calls I purchased cost the same as if I would have put on just a simple call credit spread (relatively), now I know this position is long Vega and IV on this particular stock is likely to decrease but the intent of this trade is to cover myself if the stocks keeps running up.

So the end result is I’ve obtained some good premium, (but it could have been much better because I stuffed this trade up), I feel this stock may continue running up but I’m not 100% on this.

If the stocks keeps running up follow up action may not be as painful.

Feel free to give me opinions on this, and don’t hold back on flack as i can take it.:D

It's a bit hard to comment without knowing more specifics cutz:


Underlying position
Price of the underlying
Striking prices and expiries of the options
Net Premium (debit or credit)


Cheers

[chops_a_must]

It's a bit hard to comment without knowing more specifics cutz:


Underlying position
Price of the underlying
Striking prices and expiries of the options
Net Premium (debit or credit)


Cheers

Talking options in your sleep I see. :rolleyes:

What time is it over there? Go to bed! :D

[wayneL]

Talking options in your sleep I see. :rolleyes:

What time is it over there? Go to bed! :D

I just got back from my local... sleeping in tommorrow. :o:D

[Grinder]

Its a descent hedge you got depending on your greeks, just thinking if ya stock keeps running up and IV continues to fall your backspread will start looking pretty ordinary. However, if your stock shoots the moon sometime soon your ratio wings will propell you some good coin.

Keep an eye on IV fluctuations & if you don't see a big move within a couple of weeks look to roll up & out before your long calls get eaten up in value.:2twocents

[sails]

Options are all about trade-offs and shifting risk. Obviously in your new trade, there is some added protection with the second call, however, now there is increased risk due to the larger difference between strikes and with only three weeks to expiry in December, theta could be working fairly hard against your FOTM long calls.

Have you put it into Hoadley and then run the your new back spread compared to your original trade?

Perhaps you could also look at leaving one call at your normal position and then sacrificing a little of your premium to pay for one higher? Only a suggestion as I rarely do straight credit spreads. Don't like being short gamma near expiry :eek7:

[cutz]

The underlying is BHP, the strikes are at 30 and 35, net premium is $2820, the circumstances around this trade are I initially wanted to set it up as bearcall spread and I totally cocked up the long call leg as I described in the wings thread, i.e. the hedge buy to open went in as a sell to open which I had to reverse just before the market closed and add some, so I ended up short 4, and only long 1. Last night lying awake thinking about what to do I decided to close out the hedge and introduce a higher amount of further out long calls.

The reasoning for this is if the price hovers around today’s level everything is fine, if it moves up to towards 35 with a week to go I might go for a diagonal roll. If the BHP keeps driving up I am protected from assignment due to the long puts becoming profitable. This position expires in Dec but I feel a little more comfortable with this instead of a bearcall as BHP seems to be moving up unrestrained.

Yep, I did run this through hoadlys and there is definitely more risk and theta between the strikes is a killer, but I’m more comfortable with this especially the way BHP is running.

Due to what happened yesterday this has been my sloppiest trade to date but i feel it won't bite me too hard.

[cutz]

WayneL

It's good to hear from you again.:)

[sails]

Hi Cutz,

It sounds like you are comfortable with the position and, more importantly, have a pre-determined management plan. And at least BHP has better liquidity than some.

I think one has to find their own niche in options trading and seems trial and error is the best way to get there with so many different strategies and moves available.

I have often read that managing positions is most probably the key to successful options trading - and you seem to have that under control!

Be interesting to see if Wayne has any suggestions...

[cutz]

Thanks Sails.:)

Probably not the best spread to use but due to the amount of friction in my
brain the only why I get it is through actual experience when trying new things.

In theory I guess this trade would have been suited to increasing volatility and I’m not sure if BHP can continue its surge so we’ll see how it goes.

[wayneL]

Not much really to add. If it's the risk profile you desired at the time and are aware of the risks, that's completely fine. See how it plays out.

All stuff for the experience pot.

[cutz]

G’Day Everyone

I was after an opinion on setting up spreads,

Basically I’ve set up credit vertical spreads on an US index fund, Feb expiry. I started off with the Call side then added the Put side when the market turned so I ended up with a condor, last week I closed out the short call leg which turned out to be a bit premature.

This morning I’ve started looking at the March expiries and I decided to buy some cheap OTM calls which I eventually plan to use as the hedge for the call credit spread.

Does anybody else use this strategy to put on spreads rather than putting on the spread at once? I tried this with XJO options FEB expiry, (i.e. picking up cheap calls in preparation for a bounce just before late last weeks collapse)
but as it turned out the calls I purchased are now so far OTM that the market will have to move up quite a bit to put on a viable short call leg.

Normally I set up spreads at once. Am I wasting my time legging in to spreads as described above? My first attempt with the XJO call spread looks like it may fail, as there only 17 days to go till expiry.

It’s starting to appear that the strategy I’ve described could be relying too much on picking direction which i'm finding is impossible to do these days.

Any thoughts?

[jackson8]

hi cutz

have tried this sort of stragety as well by purchasing way otm options with a fair bit of time left as a first leg into a spread
but after consideration i figure that if the market moves enough to make it profitable i then have just repurchased the position to close out for a profit with only one brokerage fee
its something i have tried to get my head around
have some wotm xjo puts which may use as an insurance to short some bhp or nab puts similiar to a credit spread but utilising index as the wings and stock options as the short ..........hope this all makes sense . its a bit early for me on a saturday morn.

[Grinder]

G’Day Everyone

I was after an opinion on setting up spreads,

Basically I’ve set up credit vertical spreads on an US index fund, Feb expiry. I started off with the Call side then added the Put side when the market turned so I ended up with a condor, last week I closed out the short call leg which turned out to be a bit premature.

This morning I’ve started looking at the March expiries and I decided to buy some cheap OTM calls which I eventually plan to use as the hedge for the call credit spread.

Does anybody else use this strategy to put on spreads rather than putting on the spread at once? I tried this with XJO options FEB expiry, (i.e. picking up cheap calls in preparation for a bounce just before late last weeks collapse)
but as it turned out the calls I purchased are now so far OTM that the market will have to move up quite a bit to put on a viable short call leg.

Normally I set up spreads at once. Am I wasting my time legging in to spreads as described above? My first attempt with the XJO call spread looks like it may fail, as there only 17 days to go till expiry.

It’s starting to appear that the strategy I’ve described could be relying too much on picking direction which i'm finding is impossible to do these days.

Any thoughts?

I don't try & leg in. Don't find it worth it, can't pick direction even in a calm environment. If I was going to do it, would got another month out, can give you more time, keep gamma away. I ailways spread em, might not be same expiry but both legs get put on at the same time.

[cutz]

Hi Guys,

I’ll put up one of my positions for comment, it’s one that’s going a tad pear shaped. What was originally an XJO iron condor has turned into a call back spread due to the fact that I closed out the put short side and added long calls as defence, the strikes are as follows, 3700/4200 ratio of 1 to 2. (6 short 12 long may ex).

Due to the market pushing upwards I am now approaching the valley of death as mazza nicely put it, no convenient instruments exist for gamma scalping, with 2 weeks to go I need a solid push up or down on the XJO.

Any tips anyone ?, I’m inclined to sit it out for 2 weeks and maybe add some more longs because anything is possible (up or down) but I’m wondering if I should roll out Monday into June in case we get bogged down around the 4250 zone.

Thanks

Cutz.

[jackson8]

Hi Guys,

I’ll put up one of my positions for comment, it’s one that’s going a tad pear shaped. What was originally an XJO iron condor has turned into a call back spread due to the fact that I closed out the put short side and added long calls as defence, the strikes are as follows, 3700/4200 ratio of 1 to 2. (6 short 12 long may ex).

Due to the market pushing upwards I am now approaching the valley of death as mazza nicely put it, no convenient instruments exist for gamma scalping, with 2 weeks to go I need a solid push up or down on the XJO.

Any tips anyone ?, I’m inclined to sit it out for 2 weeks and maybe add some more longs because anything is possible (up or down) but I’m wondering if I should roll out Monday into June in case we get bogged down around the 4250 zone.

Thanks

Cutz.

Hi cutz

I am empathetic to your situation and I don’t know that I can be of any help as I am only new to the game , but I will offer you my thoughts on the situation

Firstly one can only hope that bad sentiment will set in again and the market falls , that would be the obvious but there is no guarantee of that happening

By adding more longs are you talking about out of the money as you would need quiet a rapid push upwards for them to be of much benefit , I suppose its bit of a gamble.

Rolling out may only be prolonging the agony especially if the market keeps rising and rolling out and up it is still going to hurt. Especially as your shorts are quite deep itm.

Out of curiosity where was the market when you put the spread on and did you think about defending the position earlier in the game when the trade started going against you .

I subscribe to a thread by a usa. IC Trader who suggests making adjustments in stages as soon as the trade starts going against you . he suggests taking long positions underneath the short strike as a defensive strategy as your short becomes threatened
It obviously costs some but offers a bit of protection on any further upward movement. If the strike is further threatened he would then buy more protection of the same

I suppose there has to be a trade off between throwing more money into the hat or just plain relinquishing the position

Sorry that I can not be of more help , hopefully someone with more experience than myself can offer some tips

I will add a link to one of his latest blogs as it may be relevant to your situation
http://blog.mdwoptions.com/options_for_rookies/2009/05/trading-iron-condors-more-risk-reducing-investment-ideas.html