# Analyzing an Index Option Write



## wayneL (19 December 2008)

Because I'm bored, I thought I'd go through a way to choose an option write on the SP 500 via SPY(AMEX)

As the december expiry is upon us, I am looking for a new option write.

With Xmas and everything, there are less than 20 trading days till the Jan expiry, so that is the analysis period.

In the last 20 days, the index has risen 12% from a major low.

Since 1990 the index has only ever exceeded a 12% move up in 20 trading days rise on 5 occasions. On each occasion it has been from a major low, never from a high or intermediate move.

Since 1980 the index has only ever exceeded a 12% move up in 20 days, anytime ending in January, once. That was in 1988 after the crash of Oct 1987.

Since 1990 there has never been a 12% move up in 20 trading days, after the index has already moved up 12% or more in the preceeding 20 trading days.

Implied volatility at OTM call strikes is 35%, but that is artificially low because of the days missed due to xmas, new year etc.

SPY is currently trading at $91.10

Based on IV, 1 standard deviation higher takes us to ~$100

12% higher takes us to the ~$101 strike.

We can get $60 per contract in premium at the $101 strike

That is a return of > 4% on margin for a naked call write for the month if it expires worthless. (~50% annualized).

Worth it?

I think so... as part of a portfolio of writes and with a defense plan, definitely. I believe that the probability of this trade is much higher that the statistical and implied volatility numbers suggest, given the raw numbers above, perhaps 95%.

Cheers


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## wayneL (19 December 2008)

wayneL said:


> Worth it?
> 
> I think so... as part of a portfolio of writes and with a defense plan, definitely. I believe that the probability of this trade is much higher that the statistical and implied volatility numbers suggest, given the raw numbers above, perhaps 95%.
> 
> Cheers




However:



> Murphy's Law
> Section 36, Subsection(c), paragraph(2)
> 
> Any trade posted publicly on a forum must fail. Furthermore, it shall be the only losing trade on the trader's books, and all other unposted trades on the trader's books shall be deliriously successful. Only the posted trade must fail. This law is absolute and no exceptions are allowed.


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## sails (19 December 2008)

wayneL said:


> ... as part of a portfolio of writes and with a defense plan, definitely....




Interesting Wayne!  In addition to the probability analysis you have already done on this, IMHO the defense plan would be essential to successful management should Mr Murphy stick his nose in   How would you go about defending a position like this?

eg. do you have a stop loss - or just roll up and out until the market eventually reverses - buy the underlying, etc, etc ???  If you don't want to go into details, just a general idea would be great.

Hopefully you've had your turn with Murphy and he will leave you alone this time.    However it turns out, it will be interesting to follow this trade.

Cheers


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## Grinder (19 December 2008)

It makes sense to me mathmatically and I like the R/R, however in these times I don't like writing anything less than a month or so out, nemesis gamma has hurt me too many times & mr murphy seems to hold a grudge. 

Like sails, Im interested to see the defense.


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## mazzatelli1000 (19 December 2008)

Some delta hedging perhaps...??
Overlaying other positions on top....???


Grinder, Short Gamma always strikes below the belt....
:run:


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## Grinder (19 December 2008)

I know! Does'nt like to play nice.


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## wayneL (20 December 2008)

Grinder said:


> It makes sense to me mathmatically and I like the R/R, however in these times I don't like writing anything less than a month or so out, nemesis gamma has hurt me too many times & mr murphy seems to hold a grudge.
> 
> Like sails, Im interested to see the defense.




Grinder,

Yep gamma can be like having a tiger by the tail near expiry and near the money... can be bloody uncomfortable... and difficult to defend without potentially locking in losses or reducing profit.

You can perform the same type of analysis for the February (or later) strikes. Of course you're not getting as much help from Sister Theta so to my mind it becomes a little bit more of a directional bet. But if you let it go to expiry, you still potentially have to face nemesis gamma.

In the end, with this trade, I don't believe there is a high probability of having to defend (but still laying out burnt offerings to the market Gods ).


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## wayneL (20 December 2008)

sails said:


> I  How would you go about defending a position like this?
> 
> eg. do you have a stop loss - or just roll up and out until the market eventually reverses - buy the underlying, etc, etc ???  If you don't want to go into details, just a general idea would be great.
> 
> ...






mazzatelli1000 said:


> Some delta hedging perhaps...??
> Overlaying other positions on top....???
> 
> :run:




OK let's look at where this position can hurt us. Essentially, it is the short delta running away with us if the strike is threatened, due to the high gamma.

Therefore, defense should revolve around taming, neutralizing or reversing delta, but without leaving the back door open for the market to tank and punch our eyebrows off.

Rolling up this close to expiry is to be avoided because you'll get screwed on premium and contest risk. I would prefer to stop out than do that, which is a perfectly valid defense in itself.

You could roll up and out as well, but I'd prefer to stand my ground and face off the enemy. I will typically defend well before the strike is ever threatened, because defending later, when gamma is trying to cut your liver out and eat it for lunch, is not fun.

So if the index breaks up from this little pennanty/flaggy/microconsolidation thingy it's in, in the near future, I'll start defending a little.

This could be done with a little bit of stock, just to add some deltas for a bit and re-evaluate as we go along. I wouldn't go too far with this or we'll end up too much like a short straddle... no thanks.

We can also do it with long calls at a strike lower than the sold strike. Buy the same number of calls and we've flipped the delta and we now have a bull call spread. The index can go up all it wants and we're safe, but opened up the door for a limited loss assault on the downside. We only want to do this if it looks like running away to the upside, because it messes up the who probabiltiy basis for entering the original trade.

But we can buy calls a bit at a time, creating a ratio spread. Each call we buy will push the break even point just a little bit further out, increase potential profit, but also start introducing risk to the downside. Half the number of bought calls makes a standard 2:1 ratio spread. But we don't ever have to stick to that ratio, we can do whatever we want depending what we think is going to happen.

That's my plan, but everything depends on *when* an upside move is put on and whether I think it's possible for an assault on my sold strike.

Defense is not without risk as a whippy move back down can hurt profit, or create a loss, or make us start trading like a freakin day trader on 'roids, and we have to be cognizant of that when putting defensive positions on. 
The idea is to watch premium slowly sink beneath the waves while we sit on our @ss watching, laughing maniacally... then go and have a festive dinner with friends and family after the third friday of every month. 

That's what we're trying to achieve with these trades.


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## cutz (20 December 2008)

Hi Wayne,

Your first post has added another piece to the puzzle.

I just wanted to confirm that you converted IV to monthly IV by dividing 35 by the square root of 12, and if you wanted to calculate 3 months would you divide 35 by the square root of 4? Or is that of the mark.


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## wayneL (20 December 2008)

cutz said:


> Hi Wayne,
> 
> Your first post has added another piece to the puzzle.
> 
> I just wanted to confirm that you converted IV to monthly IV by dividing 35 by the square root of 12, and if you wanted to calculate 3 months would you divide 35 by the square root of 4? Or is that of the mark.




I work out the number of trading days till expiry and use this formula:

(IV/100 * sqrt(Trading Days/252))*C


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## wayneL (20 December 2008)

Just thought I'd add that the defensive call buys mentioned above, need not be the same expiry as the sold position. You can go out a strike or two to reduce the short theta (but also reduces gamma and increases vega).


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## sails (21 December 2008)

Thanks for the detailed post on your defense strategy, Wayne.

Interesting that you wouldn't roll up and out - and yet that is what I was taught to do as the first step in defence by a seminar/broker team!  Interesting to see other ideas - thanks 

Looks like the trade is doing OK at this point in time - hope it continues to behave!


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## mazzatelli1000 (21 December 2008)

sails said:


> Thanks for the detailed post on your defense strategy, Wayne.
> 
> Interesting that you wouldn't roll up and out - and yet that is what I was taught to do as the first step in defence by a seminar/broker team!  Interesting to see other ideas - thanks
> 
> Looks like the trade is doing OK at this point in time - hope it continues to behave!




I have heard of this defence before from Dan Sheridan
BUT Wayne explains it much better!!! but with less jokes


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## cutz (21 December 2008)

So is rolling up and out an acceptable form of defense? its probably what i'll be inclined to do, although reluctantly because of the additional month added to the position.


Thanks for the IV conversion tip Wayne.


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## sails (21 December 2008)

mazzatelli1000 said:


> I have heard of this defence before from Dan Sheridan
> BUT Wayne explains it much better!!! but with less jokes




Yeah, at least Wayne's theory is in nutshell form - Dan could take at least an hour and a half to give out the same information   I haven't done Dan's courses, but have heard him on TOS a couple of times.  Have you done his mentoring course?  I've heard he's pretty good if you can put up with the drawn out sessions!


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## mazzatelli1000 (21 December 2008)

sails said:


> Yeah, at least Wayne's theory is in nutshell form - Dan could take at least an hour and a half to give out the same information   I haven't done Dan's courses, but have heard him on TOS a couple of times.  Have you done his mentoring course?  I've heard he's pretty good if you can put up with the drawn out sessions!




Hahaha, agreed!!!  I have listened to alot of Dan's free webinars on CBOE and most of it repeats the same thing over and over and over again. But in amongst them there were some great tips I picked up!!!

Sails, I did contemplate doing his course or Cottles course, but both were pretty heavy on the pocket - Dans being 7k and Cottles being much much more - he charges by the hour I believe. 

So sorry I can't comment on how good his course is, but I have heard from traders over at Elitetrader forum (back in the day when I hung out there) that he is very one-on-one, hands on and runs through lots of live trades. 

There was a forumite over at Elitetrader "theoptionccoach" who knew Cottle personally, who provided free mentoring to some newbies. I jumped on that offer for a while - was very good!!!


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## mazzatelli1000 (21 December 2008)

cutz said:


> So is rolling up and out an acceptable form of defense? its probably what i'll be inclined to do, although reluctantly because of the additional month added to the position.
> 
> 
> Thanks for the IV conversion tip Wayne.




Well, yes if you don't believe the market will reach your strike


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## sails (21 December 2008)

mazzatelli1000 said:


> Hahaha, agreed!!!  I have listened to alot of Dan's free webinars on CBOE and most of it repeats the same thing over and over and over again. But in amongst them there were some great tips I picked up!!!
> 
> Sails, I did contemplate doing his course or Cottles course, but both were pretty heavy on the pocket - Dans being 7k and Cottles being much much more - he charges by the hour I believe.
> 
> ...




Yes, have read many of OCs posts, not only at ET but also at optionetics where he posted as "spudbarge".  He had a huge thread at ET on Iron Condors on the SPX (by memory now).  Didn't pick up on his offer for free mentoring - might have been a time when I had other things and wasn't keeping up with the posts because I probably would have gone for it!  I did buy his book though.


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## theasxgorilla (21 December 2008)

I must admit that beyond the utter basics (that's being generous actually) I have no clue about options.  Which has prompted me to go back and start your options course...thankfully it's all still there, gotta love the Internet.

Looking forward to _trying_ to follow along on this one.


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## Grinder (22 December 2008)

like the thinking.. maybe later months though. Probs go with picking up some extra calls along the way as IV has come of it's recent highs. Not a fan of up & out late in the game, would prefer somekind of ratio that creates a slingshot or even an IC where I could then defend along way out, taking smaller incremental profits as I go & close out before gamma starts to take effect.


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## jackson8 (22 December 2008)

hi all 
have been selling eto's thru commsec and am wondering if someone could point me in the direction of forums that may help me understand trading  XJO S&P/ASX 200  index
are there disadvantages trading this index as opposed to others

regards
gary


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## wayneL (22 December 2008)

jackson8 said:


> hi all
> have been selling eto's thru commsec and am wondering if someone could point me in the direction of forums that may help me understand trading  XJO S&P/ASX 200  index
> are there disadvantages trading this index as opposed to others
> 
> ...



Other forums? WTF?

The finest option minds in the known universe are right here on ASF!


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## jackson8 (22 December 2008)

wayneL said:


> Other forums? WTF?
> 
> The finest option minds in the known universe are right here on ASF!




sorry i actually meant threads not forums
am an avid reader of aussie stock forums and have never bothered with any  other of the sites that may be available
my apologies wayne


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## Grinder (22 December 2008)

gary, no comment on advs & dis advs as XJO the only index with liquidity, so it's the only one to trade in Oz.  If you wanna know the basic stuff, asx website will give ya all that.


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## mazzatelli1000 (22 December 2008)

jackson8 said:


> sorry i actually meant threads not forums
> am an avid reader of aussie stock forums and have never bothered with any  other of the sites that may be available
> my apologies wayne




LOL@ intimidation tactics from Wayne


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## wayneL (22 December 2008)

jackson8 said:


> sorry i actually meant threads not forums
> am an avid reader of aussie stock forums and have never bothered with any  other of the sites that may be available
> my apologies wayne




Just yanking your chain a bit there Gary, no need to apologize. 

You could do a search, pull up the advanced search screen and type in XJO options or something. Otherwise they would basically work just like US index options... 'cept they might be European expiry.

Someone here will have the oil on them


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## cutz (22 December 2008)

Hi Gary,


I've been trading XJO options for a small while now, i haven't had any major issues. But saying that i can't really offer much of an opinion as its the only index i trade.
I guess from my perspective the only disadvantage is i can't trade them via IB, but they advise me that they will be avail. soon.


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## cutz (22 December 2008)

Gary,

Check this out http://www.asx.com.au/products/options/index_options.htm


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## wayneL (23 December 2008)

Update:

Premium has collapsed over the weekend as is often the case with the expiry of the previous series. (All my other January writes have done the same)

I got $60 per contract on Friday... with a little help from market direction, they are now worth $19 or $20 per contract. A long way to go yet, but always encouraging when a trade starts going the right way early, rather than having to start defending staright of the bat.


**keeping an eye over my shoulder for the appearance of Mr Murphy.


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## Grinder (23 December 2008)

sounds like your've got a good lead on him wayne, hope you out run him buddy.


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## jackson8 (26 December 2008)

cutz said:


> Gary,
> 
> Check this out http://www.asx.com.au/products/options/index_options.htm




couple of points i may try to get cleared up if i can 

1) the difference in strikes is 100 points at $10 per point which makes total of $1000 (intrinsic only) between strikes. 

 ex.  if i sold a 4000 call and the index finished 4100 on exp would only be up for $1000 less premium received  correct ?

2) if premium quoted for 4000 call is  0.090  = 0.090 x 1000 = total of $90 received (being for 1 contract) loss on above sold call would be $910 less epenses .
so does the premium of 0.090 represent 9 points of the index or put another way give me cover up to 4009 points

thanks for your help would be also be interested to know if there are any gotchas to look out for trading the xjo s&p/asx200
gary


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## cutz (26 December 2008)

Hi Gary,


Yep you’re correct, $1000 value between the strikes assuming the difference between strikes is 100 points.
Iress shows the XJO Jan 4000 Call last sale at 9 points therefore 9 by 10 (multiplier is $10 per point) is a last sale price of $90 per contract.





jackson8 said:


> 2) if premium quoted for 4000 call is  0.090  = 0.090 x 1000 = total of $90 received



The way you worked out your premium is correct as that’s how the commsec website quotes its prices, it also how the old protrader used to quote and it had my confused at first because it didn’t tally up with the XJO option facts sheet. So a quote of 0.090 on the comsec site equals 9 points, then times that by multiplier ($10) and you get a premium of $90.

(same as 0.09 by 1000)

Hope that helps.


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## jackson8 (26 December 2008)

cutz said:


> Hi Gary,
> Yep you’re correct, $1000 value between the strikes assuming the difference between strikes is 100 points.
> Iress shows the XJO Jan 4000 Call last sale at 9 points therefore 9 by 10 (multiplier is $10 per point) is a last sale price of $90 per contract.
> 
> ...




thanks for that cutz
thats the problem i was having trying to correlate asx information against the comsec platform.


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## mazzatelli1000 (28 December 2008)

wayneL said:


> In the last 20 days, the index has risen 12% from a major low.
> 
> Since 1990 the index has only ever exceeded a 12% move up in 20 trading days rise on 5 occasions. On each occasion it has been from a major low, never from a high or intermediate move.
> 
> Since 1980 the index has only ever exceeded a 12% move up in 20 days, anytime ending in January, once. That was in 1988 after the crash of Oct 1987.




Hey Wayne, 

Just out of curiousity is there any specific statistical software you use to reach the above conclusion or is this all done in good old excel

Reason I ask, is I am trying (HARD)  to create a database infrastructure with statsitcial analysis, options modeliing, and data mining tools on stocks/indices/commodities.

I am trying to incorporate things like for example -  there is a chart of IV and there is a huge upward spike in IV on the 26/10/2008. One can just click on the spike and "drill down" into news etc for that particular date, which is stored in our database.


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## wayneL (28 December 2008)

Just straight out donkey work with excel or amibroker if I can get it to do it.


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## mazzatelli1000 (28 December 2008)

wayneL said:


> Just straight out donkey work with excel or amibroker if I can get it to do it.




Hahaha
The "donkey work" is much quicker than what im trying to put together
But I will share the stuff once ready

Just this VBA amd SQL is giving some headaches --- time to call some IT mates


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## wayneL (29 December 2008)

No worries Mazza, will look forward to that.

FWIW a look at the Feb SP500 strike... I might be closing the Jan write early and taking a 90% profit (Market Gods willing :bowdown

There are 40 trading days until February expiry.

Since 1980:


The average move is +2.4%
The maximum up move in 40 trading days is +19%
The maximum down move in 40 trading days is -30%
The maximum up move in 40 trading days ending on the Feb strike is +16%
The maximum down move in 40 trading ending on the Feb strike days is -8.3%
One standard deviation based on 30 day historical volatility is +/-25% 
I have one more stat to add based on IV but will add that later.

NB Historical volatility is starting to trend down with 10 day HV about half the 30 day value.


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## wayneL (10 January 2009)

Update.

The calls are now almost worthless.

I've not had to do any defending and with one week to go to expiry and 12 strikes in hand, I wouldn't do any defending even with a strong upwards push from here. I just don't believe > 120 SP points up has any probability of occurring.

Festive dinner with friends and family booked.


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## theasxgorilla (10 January 2009)

wayneL said:


> Festive dinner with friends and family booked.




Well bloody done Wayne...remember to give Murphy a parting single finger salute .

Just a quick qn on this strategy...if we were in a more volatile market, like what we saw from Sept to Oct, is it best to put this strategy on ice?


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## wayneL (10 January 2009)

theasxgorilla said:


> Well bloody done Wayne...remember to give Murphy a parting single finger salute .



LOL

I'm tempted, but afraid Mr Murphy might just hold a grudge. 



theasxgorilla said:


> Just a quick qn on this strategy...if we were in a more volatile market, like what we saw from Sept to Oct, is it best to put this strategy on ice?




To be honest, during that time I stayed right the #### away from writing options unless part of a mixed spread with limited risk. But after that big fall premiums were so high you could write so ridiculously far out of the money that it was worth doing so. IIRC i posted a couple... GS @ $35, TGT @ $20 etc. Though they weren't naked writes like this.

Short answer - yes. But don't be too shy, so long as the stats add up and reward > probability of loss then it's a reasonable punt. On the other hand, professional cowards survive and profit long term, gunslingers eventually get taken out by Jesse James. Caution rules, what's the biggest risk?


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## jackson8 (16 January 2009)

hi 
am trying to find a list of xjo participants with their index weight information

have searched various sites asx , standard & poor but to no avail

could someone point me in the right direction please

regards
gary


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## cutz (16 January 2009)

jackson8 said:


> hi
> am trying to find a list of xjo participants with their index weight information
> 
> have searched various sites asx , standard & poor but to no avail
> ...




Hi Gary,

The closest I ever found is a broker index basket for the STW ASX200 fund, just click on the ASX200 index basket PDF found on this page. http://www.spdr.com.au/broker_baskets/index.html.

Comsec also gives the makeup but not the weighing, somewhere under indices or research, wasn't easy to find.


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## jackson8 (16 January 2009)

http://www2.standardandpoors.com/spf/pdf/index/SP_ASX_200_Factsheet_A4.pdf

thanks cutz
in case you are interested this link is about the most information i have been able to obtain on weighting 
it is a bit old though 
will keep searching


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