Growing pains

Rationale for exit point

Reading this forum and other sources, it appears that the pros exit their position before expiry. They usually have some sort of target/benchmark to exit eg. 50% of of max profit potential.

There must be good reasons but I can't see why. For example, you have a butterfly initiated one month before expiry. It is now 5 days before expiry and the price is at the sold strike. A large chunk of the profit (approx. 1/2) can be realised in the next 5 days. Why would one exit now and only realise 1/2 the max profit? Why not wait till expiry and get the full profit?

The only reasons I can see are:
1. Exit while the price hovers around the sold strike to avoid the risk that price runs away from the sold strike in the last week.
2. Pin risk.

Are there other more valid reasons to exit before expiry? Or am I making a wrong assumption that professional traders do not exit at expiry? Any comments/words of wisdom/thoughts/enlightenment is much appreciated.

Depends on:
1) Individuals risk:reward tolerance
E.g. Condor max profit $2. Max risk $5. Position is +$1.80. Only $0.20 premium to be earned, is the remaining premium worth the risk?

Charles Cottle: "Would I initiate the position today at these prices?"

2) Position structure
E.g. Iron Condor with short otm strikes. Time decay decelerates for otm/itm strikes during the last week compared to acceleration for atm strikes.

Wayne's Explanation

So exiting these before expiry is more desirable compared to a butterfly

My

Thanks Mazza.

Hi Fox,

Agree with what has already been said regarding closing out, no point of trying to squeeze every bit of profit only to see the position turn on you, especially since in the final couple of weeks things can get pretty twitchy.

In my case the only things that expire are the occasional leftover hedge/wing that wasn't worth the effort of trading out of, i sometimes have wet dreams of these leftovers exploding in value, no go yet, maybe sep, oct, who knows.

Actually come to think of it i probably would have done better not leaving a trail of leftovers, especially in the last few months.

Fox said:

I now understand why the pros here prefer to trade index options.

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Don't be discouraged from equity options due to this one experience. Sometimes there is a lack of premium in index options to justify being short gamma/vega.

cutz said:

Actually come to think of it i probably would have done better not leaving a trail of leftovers, especially in the last few months.

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Thanks for the disturbing imagery LOL
Are the leftovers from e.g. an IC wing strikes?

mazzatelli said:

Are the leftovers from e.g. an IC wing strikes?

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Hi Mazza,

Yep the leftovers were from what i can best describe as an index iron butterfly with slightly overweight wings being constantly moved up over the course of this new bull market.

I got in the habit of leaving put wingstrikes on due to a paranoia of a huge reversal, perhaps not the best decision in hindsight.

Ahh I getcha!!!
Always good to possess wing gamma to cover 2 & 3 sigma scenarios IMO
Your paranoia is not misplaced

All depends on the R/R when deciding to hold on. More often than not I'm out a month before expiry but with IBs I can see the logic in holding on longer.

Cutz, hear ya on the wings. My extras are'nt worth the trouble and at times I've morphed em to create a spread to offset some of the cost. Found that loading up on protection when the market is'nt really moving eats into my credit too much so have been adjusting as I go along.

Interesting thread,

Just remember that the MM are there to make money, not lose it. There is no reason why they should give anyone a free ride.

I gave up options on the Aus market 10 years ago for exactly the same reasons already explained, not enough fools to take the other side of the contract, and the MM is no fool.

There are plenty of different forums on the internet where the "wonderful", option strategies are promoted. However they assume a liquid market traded at a reasonable price, not true in the real world.

brty

brty said:

IHowever they assume a liquid market traded at a reasonable price, not true in the real world.

brty

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There are liquid options markets in the real world; just not in Oz.

Here is a run of the mill large cap I just happen to be trading atm (FCX)... and there are many that are far more liquid than this.

mazzatelli said:

Don't be discouraged from equity options due to this one experience.

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Mazz, the one experience in my earlier post was a really, really illiquid case (in hindsight). Due to inexperience and over zealousness, I jumped into the trade without checking volume first. I checked the daily trading volume recently, and found that the daily trading volume was only 8 transactions!!! Compare that with BHP which was 3200 transactions. I look at the volume a lot more closely these days.

My first CBA fly was a much more pleasant experience. I got filled in what felt like an instant, and the prices I got were pleasantly close to mid-price and very close to the fair value estimated by the modeller.

Wayne's TWS screenshot of FCX has got me drooling. I had to take a second look to confirm that they were option spreads and not Aussie share spreads :. Really tempted to trade US options but always have this fear about complications with Aussie tax returns. To guys like Grinder who have switched to the US market, has filling your tax return been made any more complicated as a result of trading US options? Or was this a fairly smooth transition ie. trading AUS options or US options did not affect how your tax returns were prepared. Again, any advice is much appreciated. Thanks.

BUNGLE 4 - Too cheap to spend on tools

Like a lot of things in life, you get what you pay. Buy a cheap wrench from China and you will not undo that rusty nut or bolt. Buy any cheap tool and you will not get the job done.

Likewise with options. When I first looked at options, I found that two types of trading tools were offered for retail customers. The first was the typical web based order entry tool which was "free". The second was the "expensive" ones like IRESS. I used the terms "free" and "expensive" in relation to dollars paid to the broker.

In hindsight, if you define "free" and "expensive" in terms of getting a good price from the MM, then the "expensive" tools can be deemed cheap and vice versa. Until I had experienced using TWS from IB, I did not know that I could tango with the MM. Prices and orders had a static (as opposed to dynamic) feel to them. Those cumbersome trading passwords of CommSec and ETRADE gives the same psychological impression of placing a share price in a queue (at least for me it did).

With the benefit of a better trading tool, suddenly the old barriers came down. I could dart in and out with bids and offers, teasing the MMs in a seductive tango. Unfortunately for me, the MM always led and I always followed . At least I could tango now. Before, I just sat in the queue, and only got filled when prices went against me.

I was also cheap on other tools as well. Hoadley's modeller was not "expensive" in hindsight as it is full of features that the "free" modeller from ETRADE did not offer. The level of understanding of my position increased by a quantum amount by having the right modeller.

Lastly, I was too cheap to spend on good books. Actually, that was not quite true. I was willing to pay for good books, but I just did not know where to find them. I do know now that if you go to Dymocks, it is unlikely that you will find the killer option book. It was the ASF that lead me to the good books. The point is, don't be a cheap skate when it comes to good books.

I was too cynical about those $3000 courses advertised on TV, where a flashing green button was a signal to buy. I was too wary about tools and resources that were highly priced. On the other hand, this forum is free, but the content is priceless. This just goes to show that price and value are not always the same thing.

At the end of the day, it is about discernment. It is up to the individual to spot sincerity, understand motive and avoid hype. Are you discerning enough to know if a book or course is good? If you are, then spend on that knowledge.

Novice lessons learnt:
1. Be on the look out for good tools and resources.
2. Pay for them and they will more than pay for themselves very quickly.
3. Discernment is the key. Beware the snake oil salesman.

Hi Fox,
There are many excellent free open source programs, so I do not completely agree with paying up for software/books.

There is a tendency to acquire all sorts of tools when starting out trading. I was guilty of that problem.

Fox said:

Those cumbersome trading passwords of CommSec and ETRADE gives the same psychological impression of placing a share price in a queue (at least for me it did).

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I wish they got rid of the silly thing (trading password), really a trap when rolling spreads in fast moving markets coupled with delays in order approval, once i had to ring them up to find out what was going on.

Anyway these days i do most of my trading through IB, makes a big difference.

BTW, Keep up the posting, it's nice seeing the options threads getting a kick along.

Fox said:

Really tempted to trade US options but always have this fear about complications with Aussie tax returns. To guys like Grinder who have switched to the US market, has filling your tax return been made any more complicated as a result of trading US options? Or was this a fairly smooth transition ie. trading AUS options or US options did not affect how your tax returns were prepared. Again, any advice is much appreciated. Thanks.

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I've only recently switched to US trading and have'nt yet filed for the 08/09 year in which I have both OZ & US options. I will prepare my speadsheets & all relevant information as per usual and let my accountant know about the US trading, when I find out the exact process with post it up.

In the meantime have a read of http://www.greencompany.com/EducationCenter/GlobalTraderTax.pdf
the bottom of page 4 lays it out best, but be sure to speak to a tax accountant on the matter as I'm told they know best

If theres any accountants reading, please feel free to provide any info.

Thanks for the tax info, Grinder. Any follow up post on this topic will be helpful to those of us newbies venturing into the US, and will be much appreciated.

BTW, I have finished reading Cottle and that thread that you sent me regarding adjustments make a lot more sense now. As always, you have been most helpful. Thank you, sir.

Surviving A.I.D.S
I'm suffering from Adjustment Intuition Deficiency Syndrome (AIDS) at the moment. I took the advice of starting small when trialling an idea. As such, I bought the smallest CBA fly I could and tried my hand at morphing it. I did not expect to achieve 100% success, but was more of a learning journey. Hence I did not title this post as a bungle, as in my previous posts.

The first thing I found was that adjustments are not cheap. Therefore, I need to budget for them in the future. My fly had such a small profit zone (or width) that a 1% move in the CBA share will cause me to be anxious. Being anxious, I felt compelled to adjust. It has been less than two weeks and I have already made 8 adjustments. At approximately $30 per adjustment, my butterfly is dying from exhaustion. All my losses are attributable to the adjustment costs.

Lessons learnt:
1. Get a reasonable profit zone for my fly.
2. Budget for a reasonable number of adjustments. I'll try for 4 in a month for my next trial.
3. Don't be trigger happy but stick to the allocated number of adjustments.
4. Find the most efficient adjustment mechanism.

The next thing I experienced was that the adjustments were not easy to execute. The standard ones like verticals were fairly easy. I only lost on slippage but the execution itself was pretty straight forward. Trying to do a -1/+3/-2 adjustment while prices are bobbing up and down, AND simultaneously battling the MM was close to impossible. I don't have the skills and experience of Sails. The MM beat me into submission. I lost quite a bit there.
Lesson learnt:
1. Use simple adjustments for now. Leave the complex ones to when I'm a big boy .

The final problem is one I am not able to solve yet. All adjustments must be done to accommodate a trader's view of the market. I am not a chartist and I don't really have an instinct for the future direction of price movements. Like most, I am responding to greed and fear when prices move in my favour or against me. This is therefore not a view of the market but more a psychological response to price movements. I'll need to resolve this. Any ideas are welcome.

Although my fly has morphed into something really ugly and is dying a painful death, it served its purpose ie. to educate. I am confident that my next one will be better.

I admire your resilience Fox, it's definitely a craft that takes practice & experience. Can't offer any real guidance on flys (especially with the Oz market where fees & slippage would eat up most of what you make) so will leave that to the others. What I can say in relation to having a view of the market, is I seldom look at charts and try not to have a view of the market, as I can't pick the right direction out of shopping centre car park let alone the market. I prefer to trade as a risk manager, managing my positions as threats to my personal risk comfort zone approaches & making adjustments using the greeks. I know that sounds broad & quite vague but it's pretty much it.

My thoughts Fox:

Fox said:

Lessons learnt:
1. Get a reasonable profit zone for my fly. Yes
2. Budget for a reasonable number of adjustments. I'll try for 4 in a month for my next trial. Do what is necessary, but as few as possible. This part is more art than science. Ideally, zero is the best number of adjustments. Sometimes many are necessary, but the fewer the better.
3. Don't be trigger happy but stick to the allocated number of adjustments. Don't limit yourself to a hard number, buts as above, the fewer the better.
4. Find the most efficient adjustment mechanism. Yes


Lesson learnt:

Although my fly has morphed into something really ugly and is dying a painful death, it served its purpose ie. to educate. I am confident that my next one will be better.

Click to expand...

Yes, great attitude.

You can read books, do courses and get au fait with all the concepts. That is essential, but there is no substitute for experience. You're going the right way about it, you'll find a way that suits you best.

My story this month is that if I had done nothing, I could have exited with excellent profit and had a festive dinner with friends and family. I made several adjustments however, which trims absolute profit potential... and I don't own a crystal ball. The market could equally have done something unpleasant - it could have been a one way market again.

As a further comment, those bid/ask spreads can be a killer when trading like this. Markets with wider spreads should be avoided or traded in a different way.

Fox said:

Surviving A.I.D.S
I'm suffering from Adjustment Intuition Deficiency Syndrome (AIDS) at the moment. I took the advice of starting small when trialling an idea. As such, I bought the smallest CBA fly I could and tried my hand at morphing it. I did not expect to achieve 100% success, but was more of a learning journey. Hence I did not title this post as a bungle, as in my previous posts.

The first thing I found was that adjustments are not cheap. Therefore, I need to budget for them in the future. My fly had such a small profit zone (or width) that a 1% move in the CBA share will cause me to be anxious. Being anxious, I felt compelled to adjust. It has been less than two weeks and I have already made 8 adjustments. At approximately $30 per adjustment, my butterfly is dying from exhaustion. All my losses are attributable to the adjustment costs.

Lessons learnt:
1. Get a reasonable profit zone for my fly.
2. Budget for a reasonable number of adjustments. I'll try for 4 in a month for my next trial.
3. Don't be trigger happy but stick to the allocated number of adjustments.
4. Find the most efficient adjustment mechanism.

Click to expand...

Hi Fox, well done on your experiment and totally agree with playing with small lots in the name of education. And yes, Oz minimum fees are a killer when trading spreads in small lots. I chose to do my options learning in the Oz market due to it being daylight hours, but certainly paid a high price in fees for the privilege.

Fees on small lots are where IB shine as they have no minimum. $3 per contract (that may have gone up a bit since the ASX have raised their price per contract). With experimental trades with a one lot it would only take about 4-5 trades and I had paid for Iress anyway. A couple of things to note with IB and spreads - and that is assignment IF you don't have the necessary funds or shares in your account to fulfil the assignment obligations. I understand (unless it has since changed) that IB only give the first 10 minutes to close the assigned position out before they start randomly closing out positions in the account which may or may not have a thing to do with the assigned position.

The other thing with IB is that customer service can be a bit slow and cumbersome - especially if you have someone whose first language is not English!

The next thing I experienced was that the adjustments were not easy to execute. The standard ones like verticals were fairly easy. I only lost on slippage but the execution itself was pretty straight forward. Trying to do a -1/+3/-2 adjustment while prices are bobbing up and down, AND simultaneously battling the MM was close to impossible. I don't have the skills and experience of Sails. The MM beat me into submission. I lost quite a bit there.
Lesson learnt:
1. Use simple adjustments for now. Leave the complex ones to when I'm a big boy .

Click to expand...

Goodness Fox, I hope I haven't given the impression that I get a fair price on every trade - oh I wish... I have shared some of the methods (aka mind games) I have used, but yes, I have also been beaten into submission on many occasions - usually when it is a deal that has to be done. If I was that good at getting fills, I would be a bit happier to remain trading Oz options.

The final problem is one I am not able to solve yet. All adjustments must be done to accommodate a trader's view of the market. I am not a chartist and I don't really have an instinct for the future direction of price movements. Like most, I am responding to greed and fear when prices move in my favour or against me. This is therefore not a view of the market but more a psychological response to price movements. I'll need to resolve this. Any ideas are welcome.

Click to expand...

Although I have had a bit of T/A training over the years, I find I am really not much better than 50/50 in picking direction. I have found FrankD's ebook quite helpful and using his larger timeframe levels for option adjustments has worked reasonably well especially when they cluster with other T/A such as fib levels, range repeats, volume analysis, etc. Frank goes into a lot more than just his basic levels in his ebook, but personally, I found the basic, longer term levels a useful tool for me. I also watch put/call ratios for extremes together with unusually large turnover. I also often incorporate some basic time analysis - I did start a thread on it some time ago, but haven't had the time to keep it up. Time analysis can be quite labour intensive and doesn't always work.

Although my fly has morphed into something really ugly and is dying a painful death, it served its purpose ie. to educate. I am confident that my next one will be better.

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Yeah, it's tough learning, but also fun to take on the challenge. I have done many, many one lots of experimental type trades and it is where I have learned the most about the practical aspect of option trading - especially in Oz!