Options Not So Risky!

[ducati916]

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.

Some accuracy in your statement is required, are you referring to;
*Naked a LONG Put
*Naked a SHORT Put

The differences in risk are material.
jog on
d998

 

[wayneL]

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.

Oh My!!! LOL

800USD for three "pamphlets"... or $400 for the one to find out what a BWB is.

I like reading option texts... but I'll pass on that one thanks.

 

[money tree]

Some accuracy in your statement is required, are you referring to;
*Naked a LONG Put
*Naked a SHORT Put

The differences in risk are material.
jog on
d998

Some common sense in your response is required. The conversation thus far was referring to writing puts. Also, Ive never heard anyone refer to a long put as "naked" because it does not have the risk profile of a short put. Furthermore, it would be blatantly obvious that margins are paid on written positions only. There was never any confusion...

 

[ducati916]

moneytree

Some common sense in your response is required. The conversation thus far was referring to writing puts. Also, Ive never heard anyone refer to a long put as "naked" because it does not have the risk profile of a short put.

Naked puts are OK from a risk perspective,

I just wanted you to clarify your position, as your assertion to risk, is just nonsense


jog on
d998

 

[Hopeful]

Bingk6, thanks for your post.

Regarding IV, when it's high you get more premium for your sold options. I get that. But if we are talking about collars it involves one long and one short option with the same expiry, same with spreads. So although you'll pull more in you'll also pay more out so doesn't it balance out? So therefore IV doesn't have to be a major consideration with collars. But also consider that collars are for neutral to mildly bullish scenarios, high IV would imply that a big move is relatively likely and as such high IV stocks are by definition not stocks suitable to the collar strategy.

If on the other hand you are talking about writing nakeds then high IV means higher risk to the writer (and buyer). If XYZ did break below your support level and has high IV then the move is likely to be a big one - your loss on the written option would be severe. So by only sticking to high IV stocks for writing nakeds you are taking on more risk but also more reward. Same as doing it on a sluggish heavyweight stock but with a larger number of lots, but with less outlay. Therefore it's a good idea to use high IV stock from the point of view of total outlay versus total possible % ROI. I guess.

How am I doing?

 

[wayneL]

There is something I am not getting with these optionetics bozo's and their whole BWB and collar setup.

I have nothing against the underlying logic of these two strategies. They are allied to each other in that they are limited risk/limited reward directional strategies with mixed greeks.

The only difference from a P/L standpoint is that the BWB has a bit more profit potential in the middle of the distribution curve (depending on the strikes used)

Yet these clowns insist on the synthetic version of a vertical spread, in the form of the high capital requirement collar, yet they use the "true" version of the BWB.

Indeed the BWB can be constructed using long stock... so why don't they, when they do so with the synthetic vertical?

I concede there may be an answer to this, but where is it? Why can nobody explain, if indeed there is one?

Cheers

 

[professor_frink]

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!

I've been staring at this quote for ages and I just can't figure it out.
How on Earth is someone that is poor at picking direction going to make any money on ANY kind of strategy that involves the underlying moving a certain way?

 

[wayneL]

I've been staring at this quote for ages and I just can't figure it out.
How on Earth is someone that is poor at picking direction going to make any money on ANY kind of strategy that involves the underlying moving a certain way?

My crack hypothesis only gains strength with that one.

The difference is purely psychological...

...and fails to mention the ramifications of assignment in the "equilibrium" argument; which will take the position out

 

[mumtrader]

Geez Wayne, doesn't take much to rattle your cage does it? I wasn't insinuating anything insulting in my post, just trying not to assume too much. . . but if it is insults you wish to 'trade' well:

I don't have to prove anything to you. All I can say is you are all looking at this from the wrong angle, based upon a tiny snipit of a conversation that has been running for a year. It works & they are right.

Anyway, prove it to yourself, you're the one with the bone to pick apparently. If you're all so clever & these guys are so drug addicted, go over to the Optionetics board and kill them with your superior knowledge. It's been ages since anyone was foolhardy enough to debate options strategy with either of them (let alone think they can win). It'll be good for a laugh.

Or are you guys all so in awe of eachother over here (speaking of sycophants), trying to show how much Cottle you've memorised, to bother continuing your trading education?

 

[wayneL]

Geez Wayne, doesn't take much to rattle your cage does it? I wasn't insinuating anything insulting in my post, just trying not to assume too much. . . but if it is insults you wish to 'trade' well:

I don't have to prove anything to you. All I can say is you are all looking at this from the wrong angle, based upon a tiny snipit of a conversation that has been running for a year. It works & they are right.

Anyway, prove it to yourself, you're the one with the bone to pick apparently. If you're all so clever & these guys are so drug addicted, go over to the Optionetics board and kill them with your superior knowledge. It's been ages since anyone was foolhardy enough to debate options strategy with either of them (let alone think they can win). It'll be good for a laugh.

Or are you guys all so in awe of eachother over here (speaking of sycophants), trying to show how much Cottle you've memorised, to bother continuing your trading education?

As expected, no mathematics anywhere to be seen, just ad hominem attacks... weak ones at that.

As far as challenging the optionetics bozos on their own site? That would be the height of bad manners, and I can imagine the howls from the rest of the starstruck sycophants there... if you are anything to go by. No thanks.

All I want is a mathematical presentation as to how a collar achieves superior results to a vertical spread. All that has happened so far is a nasty bout of hyperbole... no facts.

I am genuinely interested if there is a difference based in fact rather than psychology.. please someone enlighten me.

Sorry mumtrader, your credibilty = 0... and the only way to repair that is to start talking proper option theory instead of bulldust.

 

[Hopeful]

Disclaimer: Options beginner with training wheels firmly attached;

Base on Friday's last-traded prices

RMBS Collar , RMBS last price 23.10

Buy RMBS @ 23.10
Buy ATM 22.50 Jan put @ -2.15
Sell OTM 25.00 Jan call @ +1.95
Net debit -0.20 - 23.10 = 23.30

Max Loss is -0.80
Max Rew is 1.70
BE is 23.30

RMBS Bull Call Spread / Bull Put Spread (perfect parity)

Buy ITM 22.50 Jan call @ -2.90
Sell OTM 25.00 Jan call @ +1.95
Net Debit 1.95-2.90 = -0.95

Max Loss is -0.95
Max Rew is 2.50-0.95=+1.55
BE is 23.45

Conclusion

In this case the collar works out slightly better as the max reward is slightly better as is the risk and BE. However, what about the risk free interest you would have earned on funds not commited to the trade as in the collar vs spread? Well, the difference in max reward is about 10% better for the collar and that's for only two months, so yea interest lost is negligable.

Let's try it with a less volitile stock, hmm say IBM:

Collar IBM last 93.35

Buy stock at 93.35
Buy put 95 Jan -2.75
Sell OTM call 100 Jan +0.45
Net -93.35-2.75+0.45= -95.65

Max loss is -0.65
Max rew is +4.35
BE is 95.65

Bull Call Spread IBM

Buy Jan 95 Call -1.85
Sell Jan 100 Call +0.45
Net Debit -1.40

Max Loss is -1.40
Max Rew is +5.00-1.40 = +3.60
BE 96.40

Once again the collar seems better with a better risk/rew profile and lower BE. Actually, the IBM collar looks quite good doesn't it? With IV at a rel. low 18% looks like a good deal. Am I missing something? I prolly messed up somewhere.

 

[wayneL]

Disclaimer: Options beginner with training wheels firmly attached;

Base on Friday's last-traded prices

RMBS Collar , RMBS last price 23.10

Buy RMBS @ 23.10
Buy ATM 22.50 Jan put @ -2.15
Sell OTM 25.00 Jan call @ +1.95
Net debit -0.20 - 23.10 = 23.30

Max Loss is -0.80
Max Rew is 1.70
BE is 23.30

RMBS Bull Call Spread / Bull Put Spread (perfect parity)

Buy ITM 22.50 Jan call @ -2.90
Sell OTM 25.00 Jan call @ +1.95
Net Debit 1.95-2.90 = -0.95

Max Loss is -0.95
Max Rew is 2.50-0.95=+1.55
BE is 23.45

Conclusion

In this case the collar works out slightly better as the max reward is slightly better as is the risk and BE. However, what about the risk free interest you would have earned on funds not commited to the trade as in the collar vs spread? Well, the difference in max reward is about 10% better for the collar and that's for only two months, so yea interest lost is negligable.

Let's try it with a less volitile stock, hmm say IBM:

Collar IBM last 93.35

Buy stock at 93.35
Buy put 95 Jan -2.75
Sell OTM call 100 Jan +0.45
Net -93.35-2.75+0.45= -95.65

Max loss is -0.65
Max rew is +4.35
BE is 95.65

Bull Call Spread IBM

Buy Jan 95 Call -1.85
Sell Jan 100 Call +0.45
Net Debit -1.40

Max Loss is -1.40
Max Rew is +5.00-1.40 = +3.60
BE 96.40

Once again the collar seems better with a better risk/rew profile and lower BE. Actually, the IBM collar looks quite good doesn't it? With IV at a rel. low 18% looks like a good deal. Am I missing something? I prolly messed up somewhere.

There's your problem Hopeful (in Red). You cannot use last traded prices. You must use live bid/ask quotes if you are to have any hope of a true comparison.

Monday night I'll have a look on live bid/ask and we'll see how we fare.

Cheers

 

[wayneL]

Hopeful... just noticed this with regards to RMBS

RMBS is delinquent in its regulatory filings

Be careful with regards to this... it might get pink sheeted (which I have no idea of the ramifications)

 

[wayneL]

Hopeful

A couple more mistakes. You have used the ask in each case. You need to use the bid price when selling option.

The actual difference in P&L is accounted for in the cost of carry on the long stock.

It will cost you ~$200 to carry 1000 stock till January expiry, which is the difference in the payoff diagrams.

This is a nuance of that need to be remembered when using option software, it does not account for stock carrying costs. This can give erroneous results when comparing strategies when stock is involved.

However, you are going well. It just takes time to get the head around all this stuff.

Cheers

 

[Mofra]

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.

Sounds like one of the very reasons I focus on verticals, the net exposure margin requirments are much lower.

However, as a simple little trader who doesn't moniter positions 24/7, I am uncomfortable with the potential loss of naked puts in that 1/1000 chance of major news decimating price.

 

[Hopeful]

WayneL, it shouldn't matter if I used last-traded prices or bid/ask prices because it's the comparison we're interested in, as long as the calculations are consistently applied between the items being compared. In any case I have re-done the calculations using the bids for sells and the asks for buys and this is what I've come up with:

RMBS 23.10 Collar , 22.50 and 25 strikes for Jan

Risk 0.85
Rew 1.65
BE 23.35

RMBS BCS using same strikes

Risk 1.00
Rew 1.50
BE 23.50

The spread has a 17% higher risk , a 9% lower reward , and an unfavourable BE. The cost of carry (0.05x23.10/6) would be worth about 0.20 for the two months. Ah ha, that explains the difference as you said! So much for the free lunch.

IBM Collar 93.35 , 95 and 100 strikes for Jan

Risk 0.75
Rew 5.20
BE 95.75

BCS

Risk 1.45
Rew 3.55
BE 96.45

Wow, big difference here. Risk is 93% higher, reward is 32% lower, and BE is worse as well. But now consider cost of carry (.05x93.35/6) at 0.78 and we are almost square! So there you go, they are the same. But you already knew that, didn't you .

In practice, for a small account holder like myself, getting peanuts for interest in my account from my broker (IB doesn't pay for the first $10,000 in USD and same for AUD), I would be much better off with a collar.

Originally Posted by http://finance.yahoo.com/q?s=rmbs
RMBS is delinquent in its regulatory filings

This is a worry, but the market doesn't seem to be concerned given the run up in RMBS since I sold a covered call .Apparently RMBS has not reported earnings for six years according to some yahoo on the Yahoo RMBS message board - but there is obviously more to it than that or else how would they be allowed to continue on the exchange for so long? I'll be bidding on a 20 put come Monday. Thanks for the warning!

However, you are going well. It just takes time to get the head around all this stuff

Thanks for the encouragement, long way to go.

 

[bingk6]

WayneL, it shouldn't matter if I used last-traded prices or bid/ask prices because it's the comparison we're interested in, as long as the calculations are consistently applied between the items being compared.

Hi Hopeful,

It depends on the liquidity of the options involved. Don't know anything about RBMS, so cannot comment specifically in this case. However, if the options are illiquid, then the last traded prices for each leg might have been traded at vastly different periods during the day. In other words, the share price applicable to when each of the legs were executed could be significantly different, which would render your comparison invalid.

However, if the options are very liquid, then you are half a chance. In any case, using live option prices against the same spot price at underlying share price is the only basis for a valid comparison.

 

[Magdoran]

Naked Puts


Determining the viability of options positions is an involved process. There are a range of different perspectives and approaches to consider.

On one level there is straight risk to reward, which is the maximum risk compared to the maximum reward. Just looking at this aspect independently however is of limited use because we also should consider putting this in a probabilistic context.

Essentially we also have to weigh the chances of events occurring, and consider the long term ramifications of adoption a particular strategy. This in part can form the basis for determining expectancy, and feeds into the longer term trading equation of overall profit and loss.

Now, if someone argues that there are ways to limit this risk, then we are talking about a very different scenario than naked puts. I’m specifically focussing on simply selling puts for premium as a strategy without any refinements.

The reality about naked puts – you have a capped reward, and a significant risk. The delta increases against you the further into the money it moves which is not what you want on the sold side of the transaction.

The potential risk, and to some extent problem with naked puts, is that since the reward is capped, and the possible losses can be quite significant (yes, that means selling a put, or being short a put, hence owing the obligation to buy a specific amount of stock at a specific price), you have to have more wins, and try to minimise losses, especially large losses.

Let me illustrate the point in addition to Wayne’s excellent example in post 14 and 15 of this thread. Theoretically a sold put could at some point reach it’s theoretical maximum loss if the stock is liquidated and moves to $0. This is a deliberately extreme example to illustrate a point. For instance, if you sold 20 Australian $80 put contracts on a stock currently trading at $80, and the stock dropped down to $2, the intrinsic exposure would be $78 per share, multiplied by 20,000 which equals $1,560,000. Selling naked puts as described in this instance has a possibility if a stock went to $2 overnight of 1.56 million Dollars.

Think about playing roulette at a casino. One of the reasons the house wins overall in the long run is having 0 and in some cases 00 where the house wins all bets other than any bets on 0 or 00. Sure, 0 doesn’t come up often, but when it does, it clears the table. It is the low probability events that in the long run claim many a victim who sells naked puts. All you need is a black swan (+4 standard deviations) move against you, and you can wipe out a host of sustained gains.

So, you could have a string of wins and be well ahead, and then you get a black swan against that position, and end up losing all your gains, and may even end up in a loss or even a significant loss position. All you need is one big loser to put a significant dent in your bank account.

Sure, some people have the capital to buy the stock and are willing to hold it (especially institutions and the larger private investors), but many don’t have the means to do this. Also, there are some who can employ this tactic at specific times quite successfully, and have worked out ways to measure the risk and determine times to use naked puts. These are professionals who have spent a lot of time doing this.

There was a case I heard about a guy who lost his retirement funds on short puts, so my comment is that if you are new to options, please be aware of the risks. You really should be well versed in the market and options to effectively use this approach. Personally I have never sold a naked put, I just don’t like the risk to reward parameters, and don’t want to invite a black swan to land on my doorstep. I figure it’s too much like tempting fate!


Regards


Magdoran

 

[Hopeful]

And from what I understand everything you've said about naked puts also applies to covered calls because the risk graphs are identical when costs of carry are accounted for. Although the psychology of trading them may be different. I am long RMBS and short a RMBS Jan $20 call. Doh. RMBS looks like it could go either way right now.

 

[Magdoran]

And from what I understand everything you've said about naked puts also applies to covered calls because the risk graphs are identical when costs of carry are accounted for. Although the psychology of trading them may be different. I am long RMBS and short a RMBS Jan $20 call. Doh. RMBS looks like it could go either way right now.

Hello Hopeful,


In answer to your statement: Yes and no.

The difference is that the volatility equation in the put tends to move up against you if you’re trying to wind out a short put while a stock is in free fall, where the sold call isn’t so much of a problem in a covered call, and the stock doesn’t have implied volatility effects.

Also, the stock is unlikely to be as leveraged as a put (depending on wether you are using margin, and if so at what level of leverage).

Sure the risk graphs look similar, but this is at expiry, and it really depends on your timing and volatility conditions if you’re going to buy back a sold put to close the position.

Hence the two perform very differently. It still boils down to how much money you have to put up compared with how much you make, and what the long term probabilities are based on the chosen strategy.

There are two ways to look at this. One is to consider the overall history and probability in all conditions, and the other is to look at probabilities in bullish markets with certain pre selected parameters. Essentially look to trade in specific market conditions with a lower probability of adverse price movements. Of course “every moment in the market is unique” (ala Douglas), and “anything can happen.”

For comparative approaches, consider if you could bought an OTM call and have it either expire workless (maximum risk) as opposed to exiting at a target price in the money (say around 300%-500% profit), this equation may outperform a range of other strategies depending on the market conditions for example.

In my view, match the strategy to your capability and the market conditions. If you think selling a naked put or using a covered call strategy will outperform any other strategy, and you are confident it will succeed, and are prepared to accept the risk, then that is your decision. Each trader and investor is the captain of their own ship…

Personally I agree with Wayne on this issue, the numbers just aren’t attractive, and I think that the limited reward which is usually available doesn’t offset the significant risks undertaken to justify the strategy. Also, I have found strategies that are more effective for me to use that in my view significantly outperform the high risk strategies.


Regards


Magdoran