Lousie Bedford quote and 'buy & writes'

Hi,
I have some BHP and SGB shares that I've been writing covered calls on. I've yet to write a hedging put...I can hear your screams of horror. I'm about to do this but before I write another option, I came across this article and was wondering whether someone could explain some of what Louise says in fairly plain English(!) if possible. I thought that writing calls was fairly conservative if you were quite happy for your shares to be exercised at the strike price.


To protect yourself from people touting the risk-free trade, here is a list of questions you can ask the seminar presenter, before paying the training fee:
1) Do your strategies distinguish between being a volatility trader or a directional trader? If so, what is your favorite volatility-based strategy?
2) Can I see a list of back-tested trading results?
3) What is a hedge ratio? What role does this play in your strategy?
4) What is the effect on my written option position if I get a spike in gamma?
5) Do you offer ongoing support in case I run into difficulty implementing the strategy?
...This type of spread should only be attempted after years of experience in the sharemarket and a full understanding of the inherent risks involved. It is not a strategy that novices can automatically make a killing with.

clancyfish said:

Hi,
I have some BHP and SGB shares that I've been writing covered calls on. I've yet to write a hedging put...I can hear your screams of horror. Nope! You won't hear me screaming. This is a decision you alone must make based on your circumstances and goals. Hedging with a put will affect your greeks, sometimes negatively depending what you are trying to achieve I'm about to do this but before I write another option, I came across this article and was wondering whether someone could explain some of what Louise says in fairly plain English(!) if possible. I thought that writing calls was fairly conservative if you were quite happy for your shares to be exercised at the strike price.


To protect yourself from people touting the risk-free trade, here is a list of questions you can ask the seminar presenter, before paying the training fee:

Oh goddammit I agree with Louise here. Great advise but a couple of dumb questions in there IMO.

1) Do your strategies distinguish between being a volatility trader or a directional trader? If so, what is your favorite volatility-based strategy?

errrr... this is actually a good question. All option strategies, whether the trader realises it or not, are volatility strategies (even if they are directional) because all option strategies have vega. Every strategy seeks (again whether the trader realises or not) to benefit, or not be hurt by, or to neutralise volatility/vega. To not consider vega is tatamount to not considering delta (direction)

I've heard on seminar clown even teach that we should actively ignore such pricing fudamentals


2) Can I see a list of back-tested trading results?

A ridiculous question. Options are impossible to backtest accurately.

3) What is a hedge ratio? What role does this play in your strategy?

Basically a smart@rse question designed to sound intellegent. A hedge ratio is simply the % of underlying that is hedged by the strategy... A covered call isn't even a true hedge, so if someone is promoting covered calls the answer will be 0

4) What is the effect on my written option position if I get a spike in gamma?

WTF is a spike in Gamma? Is it a massive move in the underlying or a move to the area of maximum gamma (i.e. ATM) or is it the result of a volatility crush wehre gamma will spike markedly ATM? Please explain Louise!

I suspect she is refering to a massive move in the underlying... I put this question in the same catagory as the previous

5) Do you offer ongoing support in case I run into difficulty implementing the strategy?

A valid question.... which I'm sure most seminar presenters will not like to answer. This could provoke the ad hominem responses typical of these clowns when the questions become curly!

...This type of spread should only be attempted after years of experience in the sharemarket and a full understanding of the inherent risks involved. It is not a strategy that novices can automatically make a killing with.

Well... I agree about the understanding the risks bit. Thats the part most seminar clowns don't tell you. But the "after years of experience" bit I don't, IF the risks are properly understood. However, I concede that that could indeed take years to achieve because of the poor standard of options education out there. Something Ms Bedford does little to alleviate IMO. Her book on writing options gets a resolute thumbs down from me.

However, I know exactly what she is getting at. Most seminars preach covered calls "ad naseum" and as a get rich quick solution with little or no risk. A simple payoff diagram will blow that theory out of the water.

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Cheers

hissho said:

Can I see a list of back-tested trading results?

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wayneL said:

A ridiculous question. Options are impossible to backtest accurately.

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May I ask why it's impossible to backtest options accurately Wayne?

Thanks a lot in advance
(p.s. I agree with you her "secret of writing options" is not that great... actually i haven't seen any good book with the word "secret" in the title)

Ive got optiongear and I can backtest current options back to their list date.

The main trouble seems to be that the option symbols get re-used so they are deleted from the databases as soon as they expire to avoid any confusion.
regards
John

hissho said:

Can I see a list of back-tested trading results?

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wayneL said:

A ridiculous question. Options are impossible to backtest accurately.

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hissho said:

May I ask why it's impossible to backtest options accurately Wayne?

Thanks a lot in advance
(p.s. I agree with you her "secret of writing options" is not that great... actually i haven't seen any good book with the word "secret" in the title)

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OK here we go:

I like to write premium on US the indexes. This basically pays my monthly wages and any profit I make on any other trades is cream.

In an ideal world, I'd write an Iron condor, go and play tennis, golf, sup espressos and come back at expiry to collect my premium. Repeat, and live the life of Reilly.

"Perhaps" you could backtest this, but I still doubt it. What amount of premium would you recieve depends on quite a few factors, volatility etc

This doesn't happen in the real world though does it? I don't write thae same index every month. I might select the SP500, NASDAQ, or Russel2000 depending on IV levels. I might not put a condor on. I might wtite naked calls, or puts, or both, without hedging. I might leg into the condor by writing a bull put first then a bear call later.

I might add to my position, I might have to defend when the goddam index starts trending! I might exit early. I might exit one side early. I might just get the hell out of Dodge city if I'm out of sync with the market. I might not put the strategy on at all a particular month because of ridiculously low IV, I might buy options instead. I might use a modified Christmas Tree Spread.

When IVs spiked early last week with a ridiculous Voatility skew, I took the opportunity to write WTFOTM options, 100 points away from the money, and got damned good premium. Since then IV has collapsed and so has all that skew. KACHING!

How could you backtest this? Impossible!

When backtesting stocks you have 3 possible vectors; price, volume and time. These vectors are easily quantifyable from a price chart. And even then there are those who believe these results should be treated with suspicion.

But with options, there are additional vectors to consider and these vectors are not easy to quantify from available information. IV will be the main culprit as IV does not necessarily reflect any hard data. The other greeks will be behaving dynamically depending on IV and you cannot quantify these historically in a backtesting scenario.

There are just WAY too many variables.

Cheers

The problems I see with backtesting options especially in Aus is that you either have data that uses the last traded price or the data uses theoretical pricing.

If it uses the last traded price, it is potentially unreliable as, for example, that option may have only traded in the morning and have nothing to do with the closing price of the underlying. Or worse still, may not have traded for several days even if the underlying or IV has moved significantly. Also, we do not know whether the last trade was buying or selling - makes quite a difference in options.

If the backtesting data uses theoretical pricing, this is certainly more relevant to each day's closing price, but does not necessarily reflect what the actual bid/asks were at that time. For example, there are intra-day IV fluctuations and often there is a bit of a spike around closing time if that option is in high demand.

If backtesting can be done with something like Option Gear, it's probably an OK place to start to get a feel for how some of these strategies work, but they don't allow for the inevitable slippage in the real options market.

Just my

Edit: Didn't see you post Wayne when I submitted this one - have probably duplicated some info

Have had a little play with the backtester and all the problems you raise arise. You have to use model premiums because australian options just aren't liquid enough to give any real idea of prices and there is no way to account for slippage or intraday volatility.

Its only good for testing over longer time frames because they only have EOD data in the database.

The other problem is just the shear amount of data, I downloaded only 16 options today. BHP and RIO where not in there with their hundreds of options - the file was 3.5meg .
John

Thanks Wayne!(and Margaret!)

so what's the solution? just learn the basics and "go for it" with a small bank to learn in the real world?

thanks again

Hissho, if you have access to live options quotes, I would suggest paper trading real time and by that I mean to get your entry/exit prices from live quotes by buying at the offer and selling at the bid. In real trading you can usually shave a bit off this, but doesn't hurt to make simulated trading a little more difficult than the real thing. Also remember to add your brokerage and ACH fees in as well.

Treat your excel spreadsheet as an account by keeping a running balance and be disciplined not to change entries! This is where you learn how to unemotionally manage your positions and you start to see the effects of the greeks for yourself. It also gives you an opportunity to try things out (have several excel accounts) to see what style of options trading works best for you.

Then, once that is consistently profitable and you have good written management plans in place, it's time to move on to very small positions (even if they only pay for brokerage to beging with) as this is where you begin to learn your emotional strengths and weaknessess.

I think these steps are important if you are planning to use spreads and especially if mixing months as well. If you are just planning to simply be long premium, then you are more dependant on getting direction right and should learn how to keep yourself out of trouble mainly with theta and IV crush.

I have also found it is possible to backtest using Hoadley to calculate theoretical prices - it's just extremely tedious Then adjust entry/exit prices to allow for the bid/ask spread as I mentioned above. I think it's still easier to enter the prices into a spread sheet rather than the Hoadley Positions Manager which I've found a bit cumbersome. One needs a lot of patience to backtest this way, and still no guarantee that prices will be correct.

FWIW I still use these methods when trialling any new ideas to make sure I have fully estimated the impact of the greeks and, just as importantly, is it a strategy that sits comfortably with my personality and risk profile.

Consider it a journey - not a destination

sails said:

I have also found it is possible to backtest using Hoadley to calculate theoretical prices - it's just extremely tedious Then adjust entry/exit prices to allow for the bid/ask spread as I mentioned above. I think it's still easier to enter the prices into a spread sheet rather than the Hoadley Positions Manager which I've found a bit cumbersome. One needs a lot of patience to backtest this way, and still no guarantee that prices will be correct.

FWIW I still use these methods when trialling any new ideas to make sure I have fully estimated the impact of the greeks and, just as importantly, is it a strategy that sits comfortably with my personality and risk profile.

Consider it a journey - not a destination

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I think something like Optiongear is a lot more accurate and definitely less tedious than working day by day with hoadley. I know I gave up after a few weeks of this and with a dedicated modeler you have access to all the actual greeks every EOD - so even without the intraday data it is quite good.
Of course the biggest problem is price and learning to drive it.
It is by no means the be all and end all. Has a few
bugs left but Hubb are updating it every month or so free and have excellent support (both tech and using) I also got a free one day training course - they supply the computer etc. WA's is coming up in july so I haven't done it yet.
I guess there are other ones around but I haven't had a real good look. Most of the yank ones wont work on the ASX because of the different stock code format and other issues.
John

NettAssets said:

Of course the biggest problem is price and learning to drive it.

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I got freaked out...i was expecting a few hundred bucks only to find it costs $3995 and $399 for annual fee!

Yeah I certainly thought twice
but It has found two trades that I wouldn't have, that so far have clocked up the 4000 bucks.(for a risk of 1800) only one of them closed so now its all up to my money management.
of course its also likely to cough up some losing ones in the future.
John

thanks guys, as always, interesting to read.

WayneL said:

This is a decision you alone must make based on your circumstances and goals. Hedging with a put will affect your greeks, sometimes negatively depending what you are trying to achieve

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So WayneL, do you see a problem with me writing covered calls against my BHP shares for some months of the year when the premium is reasonable? My goal is to hold onto the shares for 10 years, 'though if ever exercised I would make sure it was at a price I was comfortable with.

Hi Clancy,

I DON'T want to appear to be giving advise, so I try to be careful how I say this:

Writing calls over long held stock at appropriate times can be a great strategy. If it were me though, I would try to avoid being called on your stock so-as not to precipitate a Capital Gains Tax event.

This can be avoided even if the stock goes into the money, simply by closing out the written call when the remaining time value is minimimal, before expiry. You have still captured most of the extrinsic value you were after, and, if enough time/volatility extrinsic value is remaining allows you to re-write a call... if you think it is still appropriate.

I have been an outspoken critic of buy/writes as promoted by the seminar clowns, (i.e. initiated specifically as a market position, without recognition of the true risk) but yours is exactly the situation where they are indeed useful and is a different situation to that promoted by said clowns.

Cheers

Thanks WayneL, your advice is always appreciated.

PM for you Clancyfish
John