Calendar spreads

[Hello_Dollars]

EliteThink,

I hope you're right. I violated one of my cardinal rules today by buying back the short September XEO puts component of my iron condor for next to nothing, while letting my long further OTM puts run. I'm now far more delta short than I typically like to be. But everything, including the seasonality factors you pointed out, says we have to get a market retracement accompanied by a volatility expansion at some point. Of course, I'm admittedly much better at identifying where a market is likely NOT to go short-term than I am identifying where it likely will go. So my trade today could very well be taken as a good contrary indicator, giving further credence to the current inexplicable move up.

Regards,

HD

 

[ChrisM]

Quote from Hello_Dollars:

Chris,

I agree about not writing against the long option again when the near term expires. As I said, I typically like to have 2 months between my short and long options. Thus, at near term expiration, I typically close out the long option and evaluate putting on an entirely new spread.

As to why I don't have any diagonals on at the moment, it's simply because, despite all my expectations, volatility keeps going lower. While everything tells me to be long volatility here, particularly as we approach the traditionally higher vol Sept-Oct period, I continue to be confounded by the market's resiliance and complacency. At the same time, for each of the past several days I've come very close to pulling the trigger and converting the bull put spread side of my September XEO iron condor into a Sept-Nov diagonal. But since I believe in reversion to the mean when it comes to this stuff, I'll probably do it before the month is out on at least a portion of my position.

Regards,

HD

HD,

thanks for insights. I trade vertical bull put spreads myself - this is very good strategy because of its simplicity and risk/reward ratio but sometimes hard to open when even OTM options are overpriced resulting in low difference between ATM/OTM option.
Same about iron condor. I have developed my own strategy selling ATM hedged with stock, but not delta neutral, staying in little negative territory instead. It is good for relatively stable vola markets (like ETFs) but not great for stock going nuts.
Anyway, not bad alternative for markets like indices ETFs and due to its flexibility may work even better then iron condors.

I would be interested how do you pick your options. I use few services nad mostly calculate price/underlying versus internal value/underlying.

 

[Hello_Dollars]

Chris,

With the occasional exception, I currently only trade the broader market indices, with my favorite market being the XEO/OEX. While I used to spend a lot of time scanning for stocks based on theoretical pricing divergences, high relative IV or some misconceived notion that I actually had a clue as to where the underlying was headed, I eventually found the broader market a much better vehicle for credit spreads/iron condors for a number of reasons (at least for me). They include:

(1) You don't have to worry about the gap up/down moves, which can be a killer when you're gamma negative.

(2) Though I rarely allow the short options to go in the money, since the markets I trade all settle European-style, I don't have to worry about early exercise/assignment.

(3) Following the economic trends/data points is easier for me than trying to research a myriad of different industries/names, particularly when I know there are lots of people with access to a lot more info about the individual stocks than me.

(4) From a technical standpoint, closely following one or a small handful of markets has allowed me to develop a better sense of how it/they trade for purposes of determining when the range condition may no longer apply (though, as is likely evident in my recent neutral to bearish repositioning, I can still jump the gun or just be plain wrong).

(5) A narrow focus has also allowed me to develop a better feel for how the options should be priced and what constitute adequate credits for my purposes.

(6) Trade management is obviously much easier.

(7) And lastly, I get to put all those hours I was spending scanning for and researching individual names to (hopefully) better use.

Nonetheless, as you suggested, I've been thinking increasingly about adding some ETF's into the mix as a way to diversify a bit and since trading sectors as opposed to individual names would meet most of the above criteria, though not as directly as sticking to the broader market. However, knowing my strengths (and weaknesses), my inclination is to go delta neutral and purely trade volatility.

Two questions for you, if you don't mind: (1) which ETF's are you trading and (2) what specific strategies are you employing (i.e. long put/long stock, short stock/long call, etc., and in what ratio)? Thanks.

Regards,

HD

 

[nitro]

Is the (major) difference between the XEO and OEX options is that the XEO is European-Style Settlement?

nitro

 

[Hello_Dollars]

Nitro,

Yes, that's the only difference. The XEO contracts will trade at a slight discount to the OEX to compensate for this. However, when selling premium, even when hedged as I always do, there's a comfort level in not having to worry about early exercise/assignment. Hence, in my opinion, the XEO is the more appropriate product for credit spreads.

Regards,

HD

 

[nitro]

HD, thanks,

nitro

Quote from Hello_Dollars:

Nitro,

Yes, that's the only difference. The XEO contracts will trade at a slight discount to the OEX to compensate for this. However, when selling premium, even when hedged as I always do, there's a comfort level in not having to worry about early exercise/assignment. Hence, in my opinion, the XEO is the more appropriate product for credit spreads.

Regards,

HD

 

[rrisch]

Say I own an in the money October Call. I notice that the September call of the same strike has the same bid and ask as the one I own. Is there any good reason not to sell the September call at the bid? This situation is rather common with ITM options.

 

[vega]

Well, there's a couple of things to consider. First, if you sell the Sep call, you are basically giving away any kind of upside profit on the position, because for each dollar you make on the long Oct call, you lose on the Sep call. Second, your Sep call will be assigned, and in order for you to fulfill your obligation, you will either have to exericise your Oct call, and use that stock, or go and buy an equal number of shares if you want to keep you Oct call position. So, if you are now bearish on the stock, you should probable just sell the Oct call and wait to re-establish a position when you think the stock will go up, or sell the Sep call against it, losing your potential upside profits, but taking the downside risk out of the equation.

Vega

 

[ChrisM]

Quote from Hello_Dollars:

Chris,

With the occasional exception, I currently only trade the broader market indices, with my favorite market being the XEO/OEX. While I used to spend a lot of time scanning for stocks based on theoretical pricing divergences, high relative IV or some misconceived notion that I actually had a clue as to where the underlying was headed, I eventually found the broader market a much better vehicle for credit spreads/iron condors for a number of reasons (at least for me). They include:

(1) You don't have to worry about the gap up/down moves, which can be a killer when you're gamma negative.

(2) Though I rarely allow the short options to go in the money, since the markets I trade all settle European-style, I don't have to worry about early exercise/assignment.

(3) Following the economic trends/data points is easier for me than trying to research a myriad of different industries/names, particularly when I know there are lots of people with access to a lot more info about the individual stocks than me.

(4) From a technical standpoint, closely following one or a small handful of markets has allowed me to develop a better sense of how it/they trade for purposes of determining when the range condition may no longer apply (though, as is likely evident in my recent neutral to bearish repositioning, I can still jump the gun or just be plain wrong).

(5) A narrow focus has also allowed me to develop a better feel for how the options should be priced and what constitute adequate credits for my purposes.

(6) Trade management is obviously much easier.

(7) And lastly, I get to put all those hours I was spending scanning for and researching individual names to (hopefully) better use.

Nonetheless, as you suggested, I've been thinking increasingly about adding some ETF's into the mix as a way to diversify a bit and since trading sectors as opposed to individual names would meet most of the above criteria, though not as directly as sticking to the broader market. However, knowing my strengths (and weaknesses), my inclination is to go delta neutral and purely trade volatility.

Two questions for you, if you don't mind: (1) which ETF's are you trading and (2) what specific strategies are you employing (i.e. long put/long stock, short stock/long call, etc., and in what ratio)? Thanks.

Regards,

HD

HD,

I agree with all above. Answering your questions:

1. I trade mostly Qs. While DIA might be considered as well, Qs have more interesting opportunities due to its nature.

2. For Qs I use butterlfys, calendar/vertical spreads so far. I also trade vertical spreads but not in Qs market. I find highly volatile optionable stocks much better for this and actually it might be interesting to study how often these stocks can produce decent returns concerning only the fact that its ATM option is overpriced.
Well, these stocks are very risky ones but then vertical spreads give you what you need - protecting you on downside, which is the most important part of this strategy.

Talking about selling ATM hedged with stocks - this strategy might be appropriate for XEO/OEX due to is nature. There is no one key ratio. I test profitable range vs. price action. Some discretionary AT is applied as well giving me general idea of possible support/resistance channel.

And question for you, if you don`t mind:

par.2 - you say you rarely allow short option to go ITM, so what do you do if market goes by ? Closing or rolling over ?

Regards,

Chris

 

[rrisch]

Thank you Vega. I suppose the scenario I have in mind is that the stock drops in price before September expiration and I buy back the call at a profit. Since the stock is volatile, I suppose it will go back at least to the present level before October expiration.

I do know that ITM calendar spreads are not popular, but I am wondering if some such strategy as I am suggesting does work with stocks with a high historical volatility on which you are long term bullish but short term unsure: Buy a long term, deep in the money option and sell the front month option at the same strike. Often this will make only a small debit. A superficial examination seems to indicate that there is little downside but a fair chance for month after month upside. Well where is the fallacy in the thought?