Better than covered calls (IMO)

wayneL · 7 December 2008

wayneL said:
XJO SV's are generally ~8%, which is similar to the Dow and S&P500. However Nasdaq SV's are ~12% and Russel SV"s are ~15%....which is a bit better. But still lower than a lot of stocks.

My how things change.

The image below is SV/IV for SPY(AMEX) for the previous 24 months. Apart from the obvious thing that volatility is through the roof (we all kinda suspected that was the case huh? ), but that IV is underpricing SV at the moment.

In the past, IV has been pretty good at predicting the eventual SV looking forward 4 to 6 weeks, but so far in this volatile period, it hasn't. With the benefit of hindsight, the high volatility was a buy, rather than a sell. This "high IV is not necessarily a sell" is a point I've tried to get across in other threads.

The big question is this: IV is still predicting a fall in realized volatility, is the market right or wrong? <opinion>If so short puts or put credit spreads/call debit spread are the go. If not, it's got long put written all over it. </opinion>

Getting it wrong is going to be costly. ATM verticals might be a way to play it though

How about delta neutral and short gamma spreads? Not for this little black duck, not at the moment.

For the moment, I'm going against the whole premise of this thread and say I'm finding better risk/reward opportunities in individual stocks, with Way The F### OTM credit spreads and the odd straddle/gamma trade.

Until things settle down, and unless trying to acquire stock, the strategies I wanted to talk about in this thread are on hold. Their time will of course come again.

cutz · 7 December 2008

wayneL said:
3/ Naked calls/puts a viable strategy. Lets face it. Only the trader with a death wish writes naked calls.

G’Day Wayne,

Back in 05 you mentioned that going naked could be suicidal, what’s your opinion on this strategy in today’s climate, reason I ask is I often put on a naked put position on the index as it’s one way to take advantage of the high volatility at the moment, but reading in to this I find more often than not naked is not the way to go due to its unlimited risk profile.

Curious to hear what a seasoned trader has to say about this.

wayneL · 7 December 2008

cutz said:
G’Day Wayne,

Back in 05 you mentioned that going naked could be suicidal, what’s your opinion on this strategy in today’s climate, reason I ask is I often put on a naked put position on the index as it’s one way to take advantage of the high volatility at the moment, but reading in to this I find more often than not naked is not the way to go due to its unlimited risk profile.

Curious to hear what a seasoned trader has to say about this.

I have no problem with naked calls (or puts) on the indexes, so long as you have a defense strategy if it starts moving against you and are aware of the risk. However, at the moment, I personally wouldn't go unhedged on the put side because there are possibly still unhatched poisons in the mud.

I just wouldn't go naked calls on stock, ever... think Volkswagen

... or puts unless happy to be assigned or WTFOTM and manageable face value (in other words, don't sell large numbers of contracts).

The stress test is - how would your account be affected if the unimaginable became reality? Really scare yourself, then trade to that.

drsmith · 7 December 2008

wayneL said:
I have no problem with naked calls (or puts) on the indexes, so long as you have a defense strategy if it starts moving against you and are aware of the risk. However, at the moment, I personally wouldn't go unhedged on the put side because there are possibly still unhatched poisons in the mud.

I'm curious for more detail on the above point.

I'm yet to venture into options but I am considering writing out of the money put options over ASX indices for option premium income generation. So far I have established a basic knowledge to the extent that I know the index options are European and cash settled but the detail such as potential margin requirements I am yet to investigate.

wayneL · 7 December 2008

drsmith said:
I'm curious for more detail on the above point.

I'm yet to venture into options but I am considering writing out of the money put options over ASX indices for option premium income generation. So far I have established a basic knowledge to the extent that I know the index options are European and cash settled but the detail such as potential margin requirements I am yet to investigate.

I'm not sure what Aussie margin is on Index options, but in the US it is an Algorhythm(?) that works around a basis of 15% of the face value of the strike price of the contract, less consideration of premium received and how far OTM they are... something along those lines.

Basically, you have to think like a bookie or an insurance actuary. The sum of rewards over a period of time has to exceed the sum of risks. Just writing options for income willy nilly every month can be like snatching pennies from the path of a steamroller. Sooner or later, you could get squashed.

eg If the option position has a 30% chance of being in the money, reward needs to be higher than 30% of your risk to ensure profit over the long term.

Consider the following results:

+$100
+$100
+$100
+$100
+$100
+$100
+$100
+$100
+$100
-$1000

You lose even though you won 9/10

+$100
+$100
+$100
+$100
+$100
+$100
+$100
+$100
+$100
-$700

You win

This is the reality of writing options.

If you have trading ability, you can dynamically hedge potential losses and/or actively flip delta to +,-, or neutral to enhance short option positions and make the above look a whole lot better.

mazzatelli1000 · 7 December 2008

wayneL said:
Just writing options for income willy nilly every month can be like snatching pennies from the path of a steamroller. Sooner or later, you could get squashed.

I love this analogy!!!!!

cutz · 7 December 2008

drsmith said:
I'm curious for more detail on the above point.

I'm yet to venture into options but I am considering writing out of the money put options over ASX indices for option premium income generation. So far I have established a basic knowledge to the extent that I know the index options are European and cash settled but the detail such as potential margin requirements I am yet to investigate.

Hi drsmith

There's a margin estimator for the aussie market here, make sure you put a minus in front of the no of contracts in the appropriate page.

http://www.asx.com.au/opc/OpcStart?Mode=M

Grinder · 8 December 2008

wayneL said:
How about delta neutral and short gamma spreads? Not for this little black duck, not at the moment.

Ditto on the atm vertcials, & straddles in particular would've paid off with IV the way it is & the moves we've seen. However the chunky premium is tasty, so hows about combining both by staying delta neutral & shorting vega whilst minimizing the gamma factor, then buying a straddle or some puts ratioed along the way? Could benefit or at least be hedged either way?

wayneL · 8 December 2008

Grinder said:
Ditto on the atm vertcials, & straddles in particular would've paid off with IV the way it is & the moves we've seen. However the chunky premium is tasty, so hows about combining both by staying delta neutral & shorting vega whilst minimizing the gamma factor, then buying a straddle or some puts ratioed along the way? Could benefit or at least be hedged either way?

OK been having a play with this idea and can't get the greeks how I would want them. How would you go about structuring it? ... I'm open to all ideas.

Cheers

Grinder · 8 December 2008

wayneL said:
OK been having a play with this idea and can't get the greeks how I would want them. How would you go about structuring it? ... I'm open to all ideas.

Cheers

Here's my thinking, leg into or open a credit spread with IV up in it's highest percentile and do the same on other side to create a IC. Would want to catch good premium without the effects of gamma implosion. Do so by opening up a delta neutral position (or as close to as possible) a few months out, thus taking in alittle theta and being short vega & gamma. Pick up some puts/calls atm in the front month or otm in same month to hedge against the postion. When underlying swings big, reverse gamma scalp (not sure if this is what you call it) buying back the profitable side and allowing the calls/puts of the losing side to come into play to cover losses. Timming plays a big part when picking up call/puts for protection to get em cheap enough to not eat into the spread. Please tell me if you think it's crap?

Sir Gordon Gecko · 26 June 2011

Hey WayneL

Is there a link you can send me on the blogged strategy, I've been trading options using various so called mentors promise the earth deliver nothing, I learnt alot, learn how to fish!

I have 5yrs trading experience with options & agree with the whole equity vs Index point of view, i understand most of what was discussed but need to digest & have examples etc to comprehend,

Many thnx SGG

wayneL said:
I have been posting this on another forum. Thought I'd copy it to here as well:

========================================================

Covered calls are promoted as a cashflow panacea/certain income by certain wealth seminar promoters. I have always begged to differ.

Once again though, I am at pains to point out that they do have their place, under certain circumstances.

It seems the feature that is attractive to people is the positive theta. In other words, people want a stream of income.

The problem with covered calls depends on the situation.

1/ If a call is sold on an existing share holding, there is always the risk of your shares being called away. If you have significate capital gains realized by this transaction, a taxable event would have been precipitated and the tax man will have his hand straight in your pocket and will take more than the call premium you recieved.

No problem you say. I can roll up and/or out or close out the position. This is true, but this always beggs the question: "Why not a pure option play instead?" This way your longterm shareholding is not involved in the risk profile.

The downside of the pure option play (sold put) is that you will need extra cash to cover the put. In the event of a gap down, you will end up with more stock, possibly that you do not want.

2/ If the call is sold and the shares bought at the same time (buy write), you are intitiating a stand alone strategy. Many beginners do not understand the risk profile of such a strategy....limited upside and undefined, but very much larger possible downside.

Once again the same question: ""Why not a pure option play instead?" The risk profile is identical.

Again, theoretically, defence is possible, but with stocks there is always the risk of gaps. Particularly when there is attractive IV (and therefore premium)

There has been sooooooooooo many traders blown out of the water this way.

Credit spreads are not a hell of a lot better, particularly with near expiry/low IV options....risk/reward is crap.

When writing options we are looking for premium income, but we want to minimise risk.

Individual stocks carry substantial risk, only rank novices don't realize this. (sorry if this sounds harsh but its true)

Answer: Index options!

With index options the individual stock risk from adverse news etc is virtually negated, and you are only exposed to overall market risk. This market risk is easily defended against with the underlying future or ETF or bought options.

The person who wants to retire and write options for a living would do well by looking at these.

Suitable strategies:
Naked writes
Written straddles/strangles
Buttereflies/Condors

Not forgetting, these can be legged into fairly safely, sans individual stock risk and possibility of large gaps.

Discuss?

Cheers

Better than covered calls (IMO)

wayneL

VIVA LA LIBERTAD, CARAJO!

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Grinder

Don't feed the bear!

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