Bullets & Conversions
- Thread starter Hoyler
- Start date
def
Sponsor
A purchase of stock and the sale of a Call combined with a purchase of the same strike put = conversion (the opposite would be a reversal).
if one leg of an option gets mis-priced you may be able to lock in a profit by putting on the synthetic short (SC & LP) vs purchasing the stock.
By selling a call and buying a put with the same strike you could synthetically sell a stock on a down tick - in practice you'll probably have a tough time beating professionals and experience option traders to any mis-pricings.
if one leg of an option gets mis-priced you may be able to lock in a profit by putting on the synthetic short (SC & LP) vs purchasing the stock.
By selling a call and buying a put with the same strike you could synthetically sell a stock on a down tick - in practice you'll probably have a tough time beating professionals and experience option traders to any mis-pricings.
I might be remembering it wrong, but I think bullets were popularized in the early 90s by hedge funds and private trading firms (who could get special margin treatment) as a way of trying to beat the uptick rule. As I recall, you start off by putting on an effectively neutral stock and option position like this:
Buy 100,000 JNPR @ 60 3/4
Sell 1000 JNPR May 60 calls @ 7 3/4
Buy 1000 JNPR May 60 puts @ 7
Basically this is a completely neutral initial position (i.e., zero risk/zero reward) and remains neutral regardless of what happens to the stock price. However, without the long stock it becomes a synthetic short. So when you want to "short" the stock, you just sell the long stock position. Since you're not shorting (you're actually selling long), the uptick rule doesn't apply.
So let's say the stock is currently at 60 and you want to short it. So you just dump the stock at 60 without regard for the uptick rule. Assuming you're right and the stock drops to say 58, you can buy back your 100,000 shares @ 58. Because of the options, you've locked in your $200,000 profit. You can keep doing this and (assuming you're right in your "shorting" overall), the net position keeps accumulating your profit for you.
I believe this used to only be done by hedge funds and certain trading firms that could take advantage of special margin for this kind of position though.
But I believe that under the new margin rules (assuming you have a broker who recognizes the special margin rules for long stock/long puts and/or collars) an individual could do something similar.
But to avoid being naked calls during the period when you are flat the equity, you'll probably have to do something like (in the example above) buy some 90 calls @ 1/2 so that when you're flat the equity, the short calls are effectively spread and you're not really naked the calls.
Your margin requirement will be higher than a hedge fund of course - a hedge fund would have to put up a very tiny amount of margin for the above position, but an individual even under the new rules would have to post 10% margin. So if let's say you wanted to do the above for 1,000 shares (instead of 100,000), you'd use 10 option contracts each and your margin would be 10% of $60,000 = $6,000. You'd still have a completely neutral starting position, but unlike the hedge fund you'd still have to post the 10% ($6K) in margin to hold it on maintenance margin (your initial margin would be $30,000 to set it up).
You'd also need to buy 10 May 90 calls for $500 and during the periods where you're flat the equity, your margin requirement would be $30,000 (30 point spread * 10 contracts on the 60/90 call spread). But, depending on your broker, you might never run into that if you never carried a flat equity overnight (i.e., you always bought back your 1,000 shares before the close).
The practicality of doing this is very dependent on your particular broker's margin rule recognition and intraday margin procedures. At a place like Bright Trading I imagine this would be easy to do. At a normal retail brokerage, it'll probably be anywhere from complicated to impossible.
If I've remembered "bullets" incorrectly, please someone jump in. Also, maybe def can comment on whether this kind of thing is practical at IB based on their particular margin rule recognition and handling of intraday margin requirements.
Buy 100,000 JNPR @ 60 3/4
Sell 1000 JNPR May 60 calls @ 7 3/4
Buy 1000 JNPR May 60 puts @ 7
Basically this is a completely neutral initial position (i.e., zero risk/zero reward) and remains neutral regardless of what happens to the stock price. However, without the long stock it becomes a synthetic short. So when you want to "short" the stock, you just sell the long stock position. Since you're not shorting (you're actually selling long), the uptick rule doesn't apply.
So let's say the stock is currently at 60 and you want to short it. So you just dump the stock at 60 without regard for the uptick rule. Assuming you're right and the stock drops to say 58, you can buy back your 100,000 shares @ 58. Because of the options, you've locked in your $200,000 profit. You can keep doing this and (assuming you're right in your "shorting" overall), the net position keeps accumulating your profit for you.
I believe this used to only be done by hedge funds and certain trading firms that could take advantage of special margin for this kind of position though.
But I believe that under the new margin rules (assuming you have a broker who recognizes the special margin rules for long stock/long puts and/or collars) an individual could do something similar.
But to avoid being naked calls during the period when you are flat the equity, you'll probably have to do something like (in the example above) buy some 90 calls @ 1/2 so that when you're flat the equity, the short calls are effectively spread and you're not really naked the calls.
Your margin requirement will be higher than a hedge fund of course - a hedge fund would have to put up a very tiny amount of margin for the above position, but an individual even under the new rules would have to post 10% margin. So if let's say you wanted to do the above for 1,000 shares (instead of 100,000), you'd use 10 option contracts each and your margin would be 10% of $60,000 = $6,000. You'd still have a completely neutral starting position, but unlike the hedge fund you'd still have to post the 10% ($6K) in margin to hold it on maintenance margin (your initial margin would be $30,000 to set it up).
You'd also need to buy 10 May 90 calls for $500 and during the periods where you're flat the equity, your margin requirement would be $30,000 (30 point spread * 10 contracts on the 60/90 call spread). But, depending on your broker, you might never run into that if you never carried a flat equity overnight (i.e., you always bought back your 1,000 shares before the close).
The practicality of doing this is very dependent on your particular broker's margin rule recognition and intraday margin procedures. At a place like Bright Trading I imagine this would be easy to do. At a normal retail brokerage, it'll probably be anywhere from complicated to impossible.
If I've remembered "bullets" incorrectly, please someone jump in. Also, maybe def can comment on whether this kind of thing is practical at IB based on their particular margin rule recognition and handling of intraday margin requirements.
You guys got it right
I will add just a little bit.
From DEf
"A purchase of stock and the sale of a Call combined with a purchase of the same strike put = conversion (the opposite would be a reversal)."
This is usually done by option players to exit an existing position. There is usually no spread for the bid/ask on conversions/reversals as a mutual agreement between all option players. They only do this position to lock in a loss or profit. Floor traders usually take the other side of commercials and when they have too much risk they will do a conversion or reversal to reduce the risk. They make money by taking the spread and reducing risk.
"if one leg of an option gets mis-priced you may be able to lock in a profit by putting on the synthetic short (SC & LP) vs purchasing the stock."
conversions /reversals can be placed by any compentent options broker for the price of a normal trade. These rarely get mispriced.
A bullet is just what Archangel said. It can usually only be done by a professional because of lower margin requirements so the tie up of capital is less to take on a position such as this. It doesn't make as much sense for someone who would time up a lot of capital to take on this position.
rtharp
I will add just a little bit.
From DEf
"A purchase of stock and the sale of a Call combined with a purchase of the same strike put = conversion (the opposite would be a reversal)."
This is usually done by option players to exit an existing position. There is usually no spread for the bid/ask on conversions/reversals as a mutual agreement between all option players. They only do this position to lock in a loss or profit. Floor traders usually take the other side of commercials and when they have too much risk they will do a conversion or reversal to reduce the risk. They make money by taking the spread and reducing risk.
"if one leg of an option gets mis-priced you may be able to lock in a profit by putting on the synthetic short (SC & LP) vs purchasing the stock."
conversions /reversals can be placed by any compentent options broker for the price of a normal trade. These rarely get mispriced.
A bullet is just what Archangel said. It can usually only be done by a professional because of lower margin requirements so the tie up of capital is less to take on a position such as this. It doesn't make as much sense for someone who would time up a lot of capital to take on this position.
rtharp
Correct me if I'm wrong, but isn't this setup the same as a collar, only that the put and call strikes are the same rather than the call higher and the put lower as in a collar? If so, I know that with IB I've been able to sell out the underlying stock from the collar and maintain the position in the options, and buy back the stock at any time. So I would assume then that if I can do that play with IB, then I would also be able to do a bullet, no?
zboy - sounds like it should work the same for you - a bullet is a conversion which is basically a zero width collar.
That must mean that IB is allowing you to go naked on the short call. Many brokers wouldn't allow that. Alternatively it means that if you're selling the stock and buying it back before the end of the day, their system is maybe not catching that you're temporarily naked on the call.
Do they recognize the lower 10% margin requirement on collars or are they still sticking you for 30% maintenance margin on the equity? They didn't used to.
When you sell the stock and then buy it back later, are you temporarily caught with a renewed 50% initial margin on the "new" long position?
Bullets tend to only be practical if you're trading through someplace like Bright, are a hedgefund, or have similar access to special margin treatment.
For them to be efficient for a retail trader, the broker would have to recognize the 10% margin on the combination equity/option position, either allow you to go naked on the call intraday or (if you add the long calls to prevent being naked) not hit you intraday for the margin on the spread, and not hit you for 50% margin when you close and then reenter the long equity leg of the combination position.
That must mean that IB is allowing you to go naked on the short call. Many brokers wouldn't allow that. Alternatively it means that if you're selling the stock and buying it back before the end of the day, their system is maybe not catching that you're temporarily naked on the call.
Do they recognize the lower 10% margin requirement on collars or are they still sticking you for 30% maintenance margin on the equity? They didn't used to.
When you sell the stock and then buy it back later, are you temporarily caught with a renewed 50% initial margin on the "new" long position?
Bullets tend to only be practical if you're trading through someplace like Bright, are a hedgefund, or have similar access to special margin treatment.
For them to be efficient for a retail trader, the broker would have to recognize the 10% margin on the combination equity/option position, either allow you to go naked on the call intraday or (if you add the long calls to prevent being naked) not hit you intraday for the margin on the spread, and not hit you for 50% margin when you close and then reenter the long equity leg of the combination position.
AA,
As I reviewed IB's margin documents, you appear to be correct regarding the 30% maintenance on the collar and 50% initial on the long equity. However, I have many times sold the stock from a collar that lasted longer than intraday, and was able to buy back the stock at a later date while not having to touch my option positions. I guess it also comes down to how much equity you have in your account and how big a position you're taking. The times I've done collars, it's usually been on 200 or 300 shares (plus 2 or 3 puts and calls), where I wasn't really pushing my equity too hard.
I also often do naked straddles, so to answer your initial question, yes, IB does allow all kinds of naked option positions. I'll be interested to try a test "bullet" to see how it goes.
As I reviewed IB's margin documents, you appear to be correct regarding the 30% maintenance on the collar and 50% initial on the long equity. However, I have many times sold the stock from a collar that lasted longer than intraday, and was able to buy back the stock at a later date while not having to touch my option positions. I guess it also comes down to how much equity you have in your account and how big a position you're taking. The times I've done collars, it's usually been on 200 or 300 shares (plus 2 or 3 puts and calls), where I wasn't really pushing my equity too hard.
I also often do naked straddles, so to answer your initial question, yes, IB does allow all kinds of naked option positions. I'll be interested to try a test "bullet" to see how it goes.