Options Not So Risky!

[wayneL]

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?

I have been doing some agitating on this topic on another board. I will report developments as they occur

So far, we have this:

This guy is on crack. He is 100% wrong and I can prove it mathematically. Bring that guy over here so I can go one on one with him in the octagon. I will rip that guy to shreds. Seriously man, where is the SEC on this ****? Hopefully by now, all you realize that a synthetic is EXACTLY the same position as it's actual. It does not matter what the stock does or how much you have to roll the position, it is 100% the same. There is NO difference. Please, someone invite that kind gentleman over here and post a link to where he is and I will pay him a kind visit.

LOL

 

[sails]

These are the potential circumstances that I think could make a difference between a collar and a bull call spread and have listed my reasons below:

1. Wayne summed up nicely on another forum what I was trying to get across in Post #29 (albeit an unlikely event) which is quoted below:

So the only difference here is that we pay the cost of carry up front when we buy the natural, whereas the cost carry is "pay as you go" for the synthetic.

So if the underlying takes a big hit early in the life of the strategy, we cop the additional loss of the cost of carry on the natural. However, as this is a black swan type event, the probability of this is quite low. Under "normal" circumstances, this is just not a factor.

2. Hopeful raised an interesting situation where funds are held with a broker that doesn't pay interest. In this case, a collar is probably superior as it would make no sense to be paying the interest component (cost of carry) in a long call in addition to having the funds sitting idle in a bank account.

3. As the interest component is usually around the risk free rate and margin lending is well above the risk free rate, I believe a bull call spread could probably be a better strategy, taking advantage of the opportunity to leverage at a lower interest rate.

4. However, dividends, capital returns and these types of situations can be detrimental with a bull call spread where the short call is at risk of assignment. The long call will not hedge the div if one is assigned on the short call the day before x-div, so that in itself can create a big difference in the profit/loss between the two strategies if the bull call is not managed properly under these types of conditions.

Any thoughts?

 

[wayneL]

These are the potential circumstances that I think could make a difference between a collar and a bull call spread and have listed my reasons below:

1. Wayne summed up nicely on another forum what I was trying to get across in Post #29 (albeit an unlikely event) which is quoted below:

2. Hopeful raised an interesting situation where funds are held with a broker that doesn't pay interest. In this case, a collar is probably superior as it would make no sense to be paying the interest component (cost of carry) in a long call in addition to having the funds sitting idle in a bank account.

3. As the interest component is usually around the risk free rate and margin lending is well above the risk free rate, I believe a bull call spread could probably be a better strategy, taking advantage of the opportunity to leverage at a lower interest rate.

4. However, dividends, capital returns and these types of situations can be detrimental with a bull call spread where the short call is at risk of assignment. The long call will not hedge the div if one is assigned on the short call the day before x-div, so that in itself can create a big difference in the profit/loss between the two strategies if the bull call is not managed properly under these types of conditions.

Any thoughts?

OMG!!!!! Those other places bring out the absolute worst in people. The behaviour of those traders is absolutely atrocious.... errr, pot calling the kettle black here ROFLMAO.

Some interesting things though, Margaret has mentioned a few great points. I'll try and collate the main points for the Lazarus blog and here.

Interesting stuff.

 

[wayneL]

These are the potential circumstances that I think could make a difference between a collar and a bull call spread and have listed my reasons below:

1. Wayne summed up nicely on another forum what I was trying to get across in Post #29 (albeit an unlikely event) which is quoted below:

2. Hopeful raised an interesting situation where funds are held with a broker that doesn't pay interest. In this case, a collar is probably superior as it would make no sense to be paying the interest component (cost of carry) in a long call in addition to having the funds sitting idle in a bank account.

3. As the interest component is usually around the risk free rate and margin lending is well above the risk free rate, I believe a bull call spread could probably be a better strategy, taking advantage of the opportunity to leverage at a lower interest rate.

4. However, dividends, capital returns and these types of situations can be detrimental with a bull call spread where the short call is at risk of assignment. The long call will not hedge the div if one is assigned on the short call the day before x-div, so that in itself can create a big difference in the profit/loss between the two strategies if the bull call is not managed properly under these types of conditions.

Any thoughts?

Margaret, I think that sums it all up pretty well. About 500 posts all boiled down to 4 points. Well done.

It's amazing that WW3 was very close to being declared, to get to that LOL

The other point to come out is that SK's explanation (posted above) is still nonsense. It took Alex M to clarify the real difference... but it is something you pointed out months ago in this thread.

Thanks

Cheers

 

[wayneL]

US margin rules to change in april.... NOT BEFORE TIME

http://sigmaoptions.blogspot.com/2007/01/new-margin-rules-for-option-positions.html

This was released in the middle of last month, and while trumpeted by a few option education firms, seems to have slipped by largely unnoticed by a lot of the retail trading community.

SEC APPROVES CBOE'S NEW PORTFOLIO MARGINING RULES TO BENEFIT CUSTOMER ACCOUNTS

CHICAGO, December 13, 2006 - The Chicago Board Options Exchange (CBOE) announced today that the Securities and Exchange Commission (SEC) approved amendments to CBOE rules that allow for expanded portfolio margining for customer accounts.The effective date of the amendments is April 2, 2007.

Today's action expands the scope of products eligible for portfolio margining to include equities, equity options, narrow-based index options, certain security futures products (such as single stock futures), and unlisted derivatives. The SEC approved portfolio margining for broad-based index options in July 2005.U.S. futures markets and most European and Asian exchanges for many years have employed risk-based margining similar to CBOE's new rules.

Snip:
The new portfolio margining rules will have the effect of aligning the amount of margin money required to be held in a customer's account to the risk of the portfolio as a whole, calculated through simulating market moves up and down, and accounting for offsets between and among all products held in the account that are highly correlated (for example, options on the S&P 500 Index, "SPX", can be offset against options on the S&P 500 Depositary Receipts, "SPY", or options on DIAMONDS (DIA) can be offset against SPX options). Current practice is to require margin based on set formulas for various strategies (i.e. some spread strategies require a certain minimum margin), regardless of what other offsetting positions were held in the account and regardless of potential market moves. For some positions the margin requirements may not change significantly, but for other positions, such as owning a protective put against a long stock position, the difference may be sizable. This is appropriate in that the margin calculation accounts for the fact that the risk of one position (long stock) is offset by the other (long put).



This will make a huge difference to the margin requirements of certain option positions as some of the examples in this document http://www.cboe.com/aboutcboe/special/marginexamples.pdf shows:

COVERED WRITE

Position
Long 500 IBM @ $91.25
Short 5 calls IBM APR 95 @ $ 2.78
Strategy margin is 50% of stock less the short option premium or $21,422.50
Portfolio margin requirement is $5,504.00

PROTECTIVE PUT

Position
Long 500 IBM @ $91.25
Long 5 puts IBM APR 90 @ $ 2.50
Strategy margin is 50% of stock plus full payment for put or $24,062.50
Portfolio margin requirement is $1,878.00

NON-CONFORMING DEBIT SPREAD

(Long must expire on or after short)
Position
Long 50 calls IBM APR 90 @ $5.45
Short 50 calls IBM JUL 100 @ $2.28
Strategy margin requires full payment for long option and
appropriate margin on short option position or $74,750.00
Portfolio margin requirement is $14,106.00



Not mentioned in the examples is a comparison of the collar under the current and new rules. Without pulling out my calculator, it's obvious that the collar margin will be competitive with the debit spread margin. Harking back to The Great Collar Vs Vertical Debate, this might just tip the balance in favour of collars.