A hypothetical scenario

[Johnmaine]

So assume you bought a stock on which options are frequently traded. Let's say you purchased 100 shares of SPY at a high $560. Then you are medically induced into a temporary coma. When you wake up from your coma, SPY is trading at a mere $280.

Since we're just talking hypotheticals, assume that you aren't allowed to sell the stock at a loss.

(a) In the first case, assume a cash balance of $30,000 in your account, in addition to the 100 shares of SPY. How would you use Options to generate a steady monthly income from these 100 shares of SPY in your account?

(b) Now assume you have no cash balance - just the 100 shares of SPY. How would your actions be different?

 

[QuasWexExort]

I would not call selling options steady monthly income. Income has no downside - if you have a job you can only gain money and not lose any. The possible depreciation of underlying is more volatile than premium collected.

But assuming you are happy with the risks/rewards of writing calls on the shares , scenario B you just write a call and scenario A you buy 1 extra call and sell 2 calls at a higher strike, at a credit.

Your premium will probably be very very low as you can't get exercised and sell shares at loss, meaning the strikes will have to be very far - near/above $560.

 

[El OchoCinco]

This question pops up a lot. If you took a huge bath on the underlying stock, options are not going to magically rescue you.

Your question is either a test question and you are looking for help or you want all the advice you can get without picking up one book or free webpage on covered calls and how they work.

You are down $28,000 in your hypo...options wont rescue that anytime soon.... You sell calls and bring in $100 at a time? You will lock in a loss at some point.

 

[Johnmaine]

Your question is either a test question and you are looking for help or you want all the advice you can get without picking up one book or free webpage on covered calls and how they work.

Neither. But in a way you are correct because I am a bit afraid that reading materials in the books available to me will limit and constrain my thinking. Medical school is like trying to drink water from a fire hose, so I am already drowning at the materials that are directed at me. I'm afraid I haven't yet been able to find a book on Options that I like, and I guess I have access to all of them through my university library. I don't think Hull is very practical, so I haven't started reading it. I like McMillan but I find Olmstead's book even more practical. However I read only one page from Olmstead's book and I found a serious error in that book that has probably let many people to make mistakes in their trading, so I gave up on that book too.

 

[El OchoCinco]

Avoid Hull, that is an academic textbook for people living in the theoretical world. McMillian has some good basic book on options. Lots of free material at the CBOE or OCC as well. Learn the basics.

But one thing I can teach you right now. If your stock tanks, nothing is going to rescue the position unless the stock moves back higher by a lot.

 

[Johnmaine]

But one thing I can teach you right now. If your stock tanks, nothing is going to rescue the position unless the stock moves back higher by a lot.

If this is true, then do option traders make money only in good weather?

 

[El OchoCinco]

That statement makes no sense to me.... If you bought SPY at $560 and it goes to $280 you lost a shitload of money. Why do you think options have a Hogwarts spell to erase that. Wow...maybe focus on medical school because you are going to have someone's life in your hands. Do you ask the teacher "Do doctors only make money when people are healthy and no work needs to be done?"

 

[ironchef]

That statement makes no sense to me.... If you bought SPY at $560 and it goes to $280 you lost a shitload of money. Why do you think options have a Hogwarts spell to erase that. Wow...maybe focus on medical school because you are going to have someone's life in your hands. Do you ask the teacher "Do doctors only make money when people are healthy and no work needs to be done?"

You could buy a few contracts of DOTM LEAP calls and wait (hope).

 

[JackRab]

I totally agree with @El OchoCinco ... you're pretty much f@#ked unless it recovers.

At -50%, buying calls will be at high IV... so hard to make anything on long calls unless it moves up very quickly and you've bought short term.

Selling calls will likely only limit the recovery and you would probably not make enough back.

You could sell puts... ATM or just OTM... they will have enough flesh on them. But you open yourself up to more downside risk... and likely margins are high. So, a relatively small drop would knock you out completely.

You still have 30k in cash correct?... Since it's the SP500... double up, buy 100 more SPY and wait a few years...
If you have no cash left... meh... still wait, but longer

And because you were wondering... usually options traders play a more neutral game... so they wouldn't be wiped out. Unless we're talking about those brilliant traders who only sell OTM puts over and over... they would be done for by the time SPY hits 500.

 

[harryp]

I am a bit afraid that reading materials in the books available to me will limit and constrain my thinking

We all stand on the shoulders of others. Learn the alphabet, learn the greek alphabet, learn the sentences / strategies, learn the paragraphs and very soon you could be truly unconstrained. There is no substitute to hard work.