Options Not So Risky!

[wayneL]

1.BWB
2.Collars
3.Gamma Scalping
4.Time spreads

I only know what a collar is though... (must read more must read more).

1. BWB ?????? Buy/Write? Nah, unless holding stock long term

2. Collars? Verticals are better

Lets say you bought stock at 50, sold a 50 call (or higher), and bought a 45 put... thats a collar.

The exact same payoff diagram gan be contructed buy simply buying the 45 call and selling the 50 call... thats a bull call spread.

Exactly the same as each other synthetically. Why would you do a collar, unless you already own the stock?

3. Gamma scalping? If the planets line up.

4. Time spreads. Yes

Plus, but not limited to:

5. Butterflies/Condors

6. Ratio spreads( indicies only IMO)

7. naked option writes and strangles (futures only imo)

Cheers

 

[wayneL]

Thanks for the reply, WayneL. One would be foolish to do bullish strategies in a bear market. But as it appears that RMBS may have found a bottom.

The May cycle on RMBS was in a raging bull... pull up a chart for the period immediately preceding

 

[Hopeful]

2. Collars? Verticals are better

Lets say you bought stock at 50, sold a 50 call (or higher), and bought a 45 put... thats a collar.

The exact same payoff diagram gan be contructed buy simply buying the 45 call and selling the 50 call... thats a bull call spread.

Exactly the same as each other synthetically. Why would you do a collar, unless you already own the stock?

Cheers

What software do you use to create your payoff/risk diagrams? Can I do it with Excel formulae?

 

[wayneL]

What software do you use to create your payoff/risk diagrams? Can I do it with Excel formulae?

http://www.hoadley.net/options/strategymodel.htm is excel based and the base version is free.

 

[sails]

Thanks for the reply, WayneL. One would be foolish to do bullish strategies in a bear market. But as it appears that RMBS may have found a bottom.

I haven't traded Options yet, but working up to it - still got lot's to read. But I would have liked to write a RMBS naked call on the 15th of Sept (my indicators told me it would likely fall from there) for about $1.30. I would now be looking to buy the stock to cover and a protective put as well.

What are your top income earning strategies? A little bird tells me that these are one person's top four:

1.BWB
2.Collars
3.Gamma Scalping
4.Time spreads

I only know what a collar is though... (must read more must read more).

Hopeful, I think your little birdie might have been reading Scott Kramer's board at Optionetics recently! Scott has actually written some articles on both collars and BWB's - might be worth searching the Optionetics article archives - they are free .

Wayne, a BWB is "Broken Wing Butterfly" which typically is described as an unbalanced fly or a ratio spread with a further out long for some protection. For example, BHP:
+1 $26.00 put
-2 $25.00 put
+1 $23.00 put

Good when IV's are high and likely to fall plus a gentle movement towards to sold strikes as one would want with a ratio spread.

The other thing I have done is start off with a butterfly and then adjust it into a BWB by expanding either the debit or credit side of the fly at support or resistance levels. It can usually be done cheaper when the market moves beyond the outer strikes of the fly than just putting it all to begin with - but still experimenting!

 

[wayneL]

Hopeful, I think your little birdie might have been reading Scott Kramer's board at Optionetics recently! Scott has actually written some articles on both collars and BWB's - might be worth searching the Optionetics article archives - they are free .

Wayne, a BWB is "Broken Wing Butterfly" which typically is described as an unbalanced fly or a ratio spread with a further out long for some protection. For example, BHP:
+1 $26.00 put
-2 $25.00 put
+1 $23.00 put

Good when IV's are high and likely to fall plus a gentle movement towards to sold strikes as one would want with a ratio spread.

The other thing I have done is start off with a butterfly and then adjust it into a BWB by expanding either the debit or credit side of the fly at support or resistance levels. It can usually be done cheaper when the market moves beyond the outer strikes of the fly than just putting it all to begin with - but still experimenting!

Ahso! It's funny how different circles can use different terminology. I know a BWB as a (rather convolutely) "butterfly with embedded vertical". LOL

Which is in fact the precice way to convert the fly to the BWB.

Another topic I noticed on Kramers board which arises here:

The risk graph of a collar and bull call spread are the same, but that is where the similarities end.
You have a much better chance of making money over the long run with collars than bull call spreads because you are always in the position and the stock acts as a flotation device by which you remain at equilibrium.

The problem with a call spread (which is not like the collar) is that if you purchase an OTM call spread the stock can go up and you still lose money if the stock does not appreciate beyond the b/e point. Then when the options expire, you have to put on a new vertical call spread. Because of the run up in the stock which you may not have capitalized on, you will likely have to pay much more for the same vertical spread out the next month or move up a strike. If this keeps happening on a slowly drifting higher stock you could be chasing profits all the time without actualizing any. It is a non-fluid trade because of the starting and stopping effect of moving options around every month.

COLLAR FIXES THIS:
The collar is superior to the vertical because you will be in the stock at all times and do not run into the static fluctuations inherent in an option only strategy. Yes, you have options in the form of a short call and long put, but that is what you want with regard to the horizontal lines of the PNL or Risk Graph of this trade. It is the horizontal line of the stock with the collar that flows while the horizontal line on a vertical has to be moved every month which can disrupt profitability.

Conclusion:
Though the profit and loss graphs of a vertical spread look the same in any given month, they are drastically different when you compare spreads v. collars over several months (or longer). It is for this reason that I think the collar is a greatly superior trade than a vertical. It is why guys who are poor at picking market direction (I am not stating Peter Achs here) can make a fortune trading collars but have a more hit-or-miss track record with verticals. This is an important distinction!

To me, he appears to be on crack here. It seems complete nonsense. Am I missing something?

 

[sails]

Ahso! It's funny how different circles can use different terminology. I know a BWB as a (rather convolutely) "butterfly with embedded vertical". LOL

Which is in fact the precice way to convert the fly to the BWB.

Totally agree - and that is exactly how I stretch out the regular fly to the "BWB" - (BWB is easier to type)!!

Another topic I noticed on Kramers board which arises here:

To me, he appears to be on crack here. It seems complete nonsense. Am I missing something?

Now that you mention it, I do remember reading that and thought at the time he couldn't have been comparing collars and verticals at the same strikes. Agree, I think he's a bit off with the fairies there. That sort of thing is the reason I have learned to never put real money on anything I read until I have tested and proved it for myself - and understand the implications of the greeks. But on the same token, try not to throw the baby out with the bathwater and I've found Scott to have some thought provoking ideas.

One possible, interesting difference between the two (collar and vertical) is that interest is technically paid upfront when purchasing the long call where this is not so when purchasing the stock. The cost of carry on the stock is not pre-paid.

Suppose the long call is a couple of months out and we know the interest component is factored into that call - then the stock tanks (now don't get excited and put that bear suit back on yet!). If the position is closed out, much of the pre-paid interest component in the call is likely to be lost whereas cost of carry is only to the time of exiting the position. Any thoughts???

 

[wayneL]

Totally agree - and that is exactly how I stretch out the regular fly to the "BWB" - (BWB is easier to type)!!

Agree, forevermore known as BWB

Now that you mention it, I do remember reading that and thought at the time he couldn't have been comparing collars and verticals at the same strikes. Agree, I think he's a bit off with the fairies there. That sort of thing is the reason I have learned to never put real money on anything I read until I have tested and proved it for myself - and understand the implications of the greeks. But on the same token, try not to throw the baby out with the bathwater and I've found Scott to have some thought provoking ideas.

One possible, interesting difference between the two (collar and vertical) is that interest is technically paid upfront when purchasing the long call where this is not so when purchasing the stock. The cost of carry on the stock is not pre-paid.

Suppose the long call is a couple of months out and we know the interest component is factored into that call - then the stock tanks (now don't get excited and put that bear suit back on yet!). If the position is closed out, much of the pre-paid interest component in the call is likely to be lost whereas cost of carry is only to the time of exiting the position. Any thoughts???

LOL @ off with fairies comment

Re the cost of carry issue. It is true that if you put the two strategies into hoadley, there will be a difference in the diagrams, particularly with longer expiries. But this is because the cost of carrying long stock is not factored in. With the cost of carry factored into carrying the long stock, the payoff once again becomes identical.

To prove this, simply substitute a synthetic long (long call, short put, for the benefit of noobs) for the long stock whereby these carrying costs are taken into account by hoadley. This difference is then corrected, and the diagrams identical.

Cheers

 

[sails]

... Re the cost of carry issue. It is true that if you put the two strategies into hoadley, there will be a difference in the diagrams, particularly with longer expiries. But this is because the cost of carrying long stock is not factored in. With the cost of carry factored into carrying the long stock, the payoff once again becomes identical.

To prove this, simply substitute a synthetic long (long call, short put, for the benefit of noobs) for the long stock whereby these carrying costs are taken into account by hoadley. This difference is then corrected, and the diagrams identical.

Cheers

I agree if you put both strategies into Hoadley and take them both right through to the expiry of the long call - the result should be identical.

However, I can't have explained it sufficiently in my last post, so will try another way.

I'll break it down - the short calls will be identical on both strategies, so won't even discuss them. We are really comparing the long call vs. stock plus long put at the same strike.

Let's say the long call (long put) is three months out. We pay more for the call vs. the put due to the interest component in the calls. Then one month later XYZ goes into a trading halt and the news is really, really bad. XYZ drops 50% when the stock trades again.

Now our previously ITM long call is extremely far OTM and the long put will now be equally deep ITM. Most, if not all extrinsic value has gone in both positions including the interest component in the calls.

So, for the purpose of this illustration, we decide to exit the position. We have probably lost most of the remaining 2 months of pre-paid interest on the calls, however, we have no further cost of carry on the stock - in other words, we have only paid for 1 month cost of carry on the stock.

Not advocating it as a better strategy by any means, but just an interesting concept that I had never thought of until recently when reading about this elsewhere.

 

[wayneL]

I agree if you put both strategies into Hoadley and take them both right through to the expiry of the long call - the result should be identical.

However, I can't have explained it sufficiently in my last post, so will try another way.

I'll break it down - the short calls will be identical on both strategies, so won't even discuss them. We are really comparing the long call vs. stock plus long put at the same strike.

Let's say the long call (long put) is three months out. We pay more for the call vs. the put due to the interest component in the calls. Then one month later XYZ goes into a trading halt and the news is really, really bad. XYZ drops 50% when the stock trades again.

Now our previously ITM long call is extremely far OTM and the long put will now be equally deep ITM. Most, if not all extrinsic value has gone in both positions including the interest component in the calls.

So, for the purpose of this illustration, we decide to exit the position. We have probably lost most of the remaining 2 months of pre-paid interest on the calls, however, we have no further cost of carry on the stock - in other words, we have only paid for 1 month cost of carry on the stock.

Not advocating it as a better strategy by any means, but just an interesting concept that I had never thought of until recently when reading about this elsewhere.

Been putting some thought into this. I'm not a natural mathematician, and options do force one to resort to maths sometimes. This is such an occasion.

It seem seems intuitive that what you are saying is correct. The problem I am having with this is:

1/ It is not born out synthetically via bought call/sold put synthetic long, and

2/ Cost of carry is also accounted for in the bought put leg of the collar, so in this way we are also being paid in advance for carrying costs as well....self cancelling?

To prove my contention is going to require equations so still working on this to settle the matter.

Any mathemeticians out there?

 

[Hopeful]

I have been watching webinars from 888 and ioe, plus reading some other stuff and the picture I'm getting is that credit/debit spreads are the way to go for consistent income. Debit spreads are slightly better due to getting a better fill when putting it on in one single transactions (because the MM is on the other side and it suits him better somehow).

What do you fellas think of credit/debit spreads, have you done well out of them?

BTW, simply selling puts has been the most profitable strategy overall over the last 5 years, however it is also the one with the highest risk/reward ratio.

 

[bingk6]

BTW, simply selling puts has been the most profitable strategy overall over the last 5 years, however it is also the one with the highest risk/reward ratio.

Hi Hopeful,

You will find a lot of people who would NOT recommend a short put strategy for very good reasons, however, I am not one of them, a I believe that it can be a very good strategy if used appropriately.

IMHO, 3 things need to be in place for this strategy to work
1) TA shows price having reached a a support level and is showing signs of rebounding
2) You must be able to absorb the consequences of being assigned stock. In other words, use this strategy only if the stock has reached an attractive level for you and that, all things being equal, you would be quite happy to purhcase the stock outright.
3) The IV for the stock should be in the upper quardrant

The reational is as follows:

If you find the stock at attrractive levels, and you are bullish, you can either buy the stock outright , or to write a put (either ATM - where extrinsic value is maximum or slightly OTM) in order to get a reasonable premium. From there, two things can happen

1) The stock continues to rebound and ultimately finish OTM, in which case, you pocket the premium, or
2) The option finishes ITM and you are assigned the stock.

For me, either of those options is superior to buying the stock outright at the start. If you are assigned the stock, you would be purchasing the stock at a level below the market price at the time if writing the option.

Now, heres the key, if the IV of the stock is high (say >35%) and you have been assigned the stock, then you do a covered call (CC) on your stock.If you really want to keep the stock, then write a OTM call. If holding the stock is not that important to you, then write ATM or ITM options to gain more premium. If CC expires OTM, then write another CC and on and on it goes. If CC is exercised, then issue another Short Put and once again on and on again.

I have found this strategy to be a very useful strategy for generating a great deal of premium. But off course, if you are using the Short Put to gamble away hugh amounts of money (as per the Wayne's example above), that is really bad news. IMHO you need to have the financial resources to cover all possibilities in order to use this strategy

 

[Hopeful]

Hi Hopeful,

You will find a lot of people who would NOT recommend a short put strategy for very good reasons, however, I am not one of them, a I believe that it can be a very good strategy if used appropriately.

IMHO, 3 things need to be in place for this strategy to work
1) TA shows price having reached a a support level and is showing signs of rebounding
2) You must be able to absorb the consequences of being assigned stock. In other words, use this strategy only if the stock has reached an attractive level for you and that, all things being equal, you would be quite happy to purhcase the stock outright.
3) The IV for the stock should be in the upper quardrant

The reational is as follows:

If you find the stock at attrractive levels, and you are bullish, you can either buy the stock outright , or to write a put (either ATM - where extrinsic value is maximum or slightly OTM) in order to get a reasonable premium. From there, two things can happen

1) The stock continues to rebound and ultimately finish OTM, in which case, you pocket the premium, or
2) The option finishes ITM and you are assigned the stock.

For me, either of those options is superior to buying the stock outright at the start. If you are assigned the stock, you would be purchasing the stock at a level below the market price at the time if writing the option.

Now, heres the key, if the IV of the stock is high (say >35%) and you have been assigned the stock, then you do a covered call (CC) on your stock.If you really want to keep the stock, then write a OTM call. If holding the stock is not that important to you, then write ATM or ITM options to gain more premium. If CC expires OTM, then write another CC and on and on it goes. If CC is exercised, then issue another Short Put and once again on and on again.

I have found this strategy to be a very useful strategy for generating a great deal of premium. But off course, if you are using the Short Put to gamble away hugh amounts of money (as per the Wayne's example above), that is really bad news. IMHO you need to have the financial resources to cover all possibilities in order to use this strategy

Thanks for your post, it sounds like a great strategy (sounds very much like the often touted "renting stocks and selling insurance" strategy that I keep running into on the net). Do you also buy a protective further OTM put when shorting puts to cover yourself against these kinds of disasters (adlr.us nbix.us opwv.us pas.ax hih.ax etc)? How long have you been able to trade consistently profitable before facing a disaster?

Interestingly, selling puts naked is actually less risky than just plain buying the stock because the stock can only go as far as zero and the premium you take in at least partially offsets the huge loss. In any case a naked put trader might want to avoid the high IV stocks as they are the ones most likely to make you homeless.

 

[Hopeful]

Thanks for your post, it sounds like a great strategy (sounds very much like the often touted "renting stocks and selling insurance" strategy that I keep running into on the net). Do you also buy a protective further OTM put when shorting puts to cover yourself against these kinds of disasters (adlr.us nbix.us opwv.us pas.ax hih.ax etc)? How long have you been able to trade consistently profitable before facing a disaster?

Interestingly, selling puts naked is actually less risky than just plain buying the stock because the stock can only go as far as zero and the premium you take in at least partially offsets the huge loss. In any case a naked put trader might want to avoid the high IV stocks as they are the ones most likely to make you homeless.

Woops! The above should have read "protective call" .

 

[Mofra]

Do you also buy a protective further OTM put when shorting puts to cover yourself against these kinds of disasters (adlr.us nbix.us opwv.us pas.ax hih.ax etc)?

Hopeful,

I tend to concentrate the majority of my trades on net credit options trades, what you are describing by taking a long position in a put further out of the money than your short put position is a vertical, specifically a bull put spread (eg short BHP $26 put, long $25 put to limit downside).

This is assuming your long/short ratio is 1/1 (which it doesn't need to be, if you'd prefer more/less downside protection based on you risk profile). In simple terms, you can at the very least calculate your maximum risk so as to determine your position size before you place a trade, which is a much overlooked piece of the trading plan IMO.

Having an idea of your maximum loss doesn't absolve you from the responsibility (to your account balance!) of examining the greeks and understanding just what you are getting into - for a start, you don't want the MMs gouging you - and if you get caught holding one leg only your delta position will be miles away for your intended exposure (if you regularly calculate your aggregate delta position to determine your overall market exposure). A couple of cents outside your plan on both legs can also scew your plan to a higher risk/reward than you anticipated as well.

There are some very experienced options professionals here who can offer better advice than I can (still a wage slave personally) but we all have to start somewhere, and you never stop learning.

Hopefully (bad pun) you keep us posted updates and best of luck on your trading journey.

Regards,

Mofra

 

[bingk6]

Thanks for your post, it sounds like a great strategy (sounds very much like the often touted "renting stocks and selling insurance" strategy that I keep running into on the net). Do you also buy a protective further OTM put when shorting puts to cover yourself against these kinds of disasters (adlr.us nbix.us opwv.us pas.ax hih.ax etc)? How long have you been able to trade consistently profitable before facing a disaster?

Interestingly, selling puts naked is actually less risky than just plain buying the stock because the stock can only go as far as zero and the premium you take in at least partially offsets the huge loss. In any case a naked put trader might want to avoid the high IV stocks as they are the ones most likely to make you homeless.

Hi hopeful,

For me, the IV of a particular stock is the KEY consideration here. Having re-read my initial post, I realize that I did not explain it as thoroughly as I would have like, so will try again.

With the Short Puts that I issue, I am in essence, offering insurance to another shareholder who may have seen his/her shares plummet in value over a period of time and who may no longer have the stomach to watch their shares fall any further and is therefore looking to buy some insurance against further falls. Having said that, it would have to be a stock that I am happy to own and whose price level has reached a level whereby its starting to look attractive to me.

With regards to the IV for the stock, I would still prefer it to have a high IV. Why? Because it offers a higher premium, relative to a lower IV stock. This means that you can write the PUT at 2 or more strikes OTM and still receive a reasonable premium, if that’s what you want. A low IV stock forces you to go closer to the action to get a reasonable premium if you know what I mean.

Secondly, my interpretation of IV in this context of selling insurance for stock is very similar to how a normal insurance company would operate, with an important difference. Say we have an insurance company offering insurance for motor vehicles. A vehicle that is parked in a “good” suburb will attract a lower insurance premium than a vehicle from a “not so good” suburb. Why ? Because of the insurance company’s perceived difference in “IV” between the two suburbs. The “not so good” suburb is perceived to be more volatile and it makes sense for the insurance company to charge a higher premium for the “not so good” suburb, because statistically it has more claims, and more likely than not, is a trend that will continue to be the case in the future.

Similarly, in the case of options, IV is dependent on the volatility of the stock. However, if I initiate a short put (say ATM, right on a support level), having a high IV does not mean that it is likely that the stock will plunge through my support and incur a big loss for me. Indeed, it is just as likely to rebound strongly off the support. A high IV should theoretically move more (in absolute value terms) in EITHER direction, relative to a lower IV stock. It does not indicate an inclination to move more in one direction than the other. The odds of a high IV stock working in my favour is comparable to the odds of a high IV stock working against me.

Compare this to the “IV” for the insurance company. With the “not so good” suburb, the insurance premium has to be higher because the odds are in favour of there being more claims in future. It is therefore only natural and prudent for the insurance company to price their premiums accordingly. With options, IMHO, receiving a larger premium (via high IV stocks) without necessarily having any more odds stacked against me one way or another, makes good sense to me.

In any case, lets just assume that that your short put is assigned and you end up with the stock. With a high IV stock, your covered calls will also bring in more premium than for a low IV stock etc etc etc .

Therefore to summarise this rather long discussion, I see no sense in issuing a short put to a low IV stock, and getting peanuts for a premium when the odds of the stock finishing in your favour are NO better than if you had issued a short put for a high IV stock. For mine, receiving a lower premium MUST imply lower risk. Otherwise, who is going to put up with receiving a low premium when they can receive a higher premium without having any further odds stacked against them. All things being equal, I will grab the larger premium anyday.

As you have probably noticed, I am not in favour of buying options, only selling them. I can’t really say why that is the case because in the scenario that I have described above (with a stock hitting a support), a vanilla long call is close to perfect, with unlimited upside and limited downside. One single leg, lower transaction costs etc etc. Perhaps the extrinsic value associated with purchasing a call is putting me off ?? I guess it has more to do with an individual’s own psychological makeup.

I trust that this answers all your questions.

Please note that these thoughts are purely my own views. I know that these views would run contrary to what some of the more seasoned options players like Wayne, Sails and Mag think. They must be thinking that after having posted all this valuable information on options trading on this forum, that this is all that this F…… M…. can come up. However, I am being truthful in that this is what I think. Now I must seek help..

 

[mumtrader]

WayneL, with respect to the quote from Kramer's board regarding collars vs. verticals, you are definitely missing the point. Of all the traders I know of, when it comes to trading this guy is certainly not on crack. He is one of the best trained floor traders in the world. Literally a guru on real options trading. The guy he mentions, Peter Achs, took US$30K and turned it into US$1.2M in 3.5 years, using dynamic collaring techniques on BBBY. I've never met a trader who did that with straight out vertical spreads. Never met a trader who could manage the volume of trades it would take to do it, employing proper money management techniques & dealing with liquidity issues.

If it hasn't happened before I'll point you in the direction of J.L Lord's books @ Random Walk Trading. This is where trading gets much less like gambling.

 

[wayneL]

WayneL, with respect to the quote from Kramer's board regarding collars vs. verticals, you are definitely missing the point. Of all the traders I know of, when it comes to trading this guy is certainly not on crack. He is one of the best trained floor traders in the world. Literally a guru on real options trading. The guy he mentions, Peter Achs, took US$30K and turned it into US$1.2M in 3.5 years, using dynamic collaring techniques on BBBY. I've never met a trader who did that with straight out vertical spreads. Never met a trader who could manage the volume of trades it would take to do it, employing proper money management techniques & dealing with liquidity issues.

If it hasn't happened before I'll point you in the direction of J.L Lord's books @ Random Walk Trading. This is where trading gets much less like gambling.

OK

Explain to me then, using collars would have differed from using the equivalent vertical spread... i.e. same strikes, and therefore almost exactly the same greeks.

Then tell me which point I am missing.

As a point of order, I can take 30k into the casino and do the same thing in 10 minutes if I'm lucky. One ocurrance does not prove anything.

That sounds ruder than it's meant to be, (and it's not meant to be ) but no-one has been able to demonstrate to me, the superiority of collars over verticals.

Cheers

 

[wayneL]

I've never met a trader who did that with straight out vertical spreads. Never met a trader who could manage the volume of trades it would take to do it, employing proper money management techniques & dealing with liquidity issues.

I'm sticking to my crack hypothesis...

How many traders have you met?

Have you actually met Achs?

Have you actually met Kramer?

Why would the transaction volume differ between the two strategies?

How would MM issues be affected?

If it hasn't happened before I'll point you in the direction of J.L Lord's books @ Random Walk Trading. This is where trading gets much less like gambling.

I'm wondering if the insult implicit in this comment was intentional.

I'm sorry, so far semingly the ranting of a starstruck sycophant...

Lets have some maths please

 

[money tree]

Naked puts are OK from a risk perspective, but your broker will demand HUGE margin payments to cover the positions! It just does not give bang for the buck over the long term.