Conservative Options Strategy

good journal, keep it coming

do you have any volatility opinions? with you selling ITMs and buying deeper ITMs, your volatility position is probably mostly flat but slightly short...

you could always think about adding in a volatility opinion by playing around the ATM options, selling the ATM if you're vol-bearish, buying it if you're vol-bullish.

good strategy though...lots of stocks to keep up with but it seems to be working for ya :)
 
Quote from arl:

I would think the main worry about early exercise is when the stock goes ex-dividend. Why not just do the same spread with puts if you don't want to worry about early exercise?
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If he is doing deep ITM call spreads, early exercise is a dream come true as it allows you to get the full value ofr the spread without having to wait for expiration. Think about it...
 
if that stock opens flat the next morning and he excercises his longs,yes,but he is very risk averse and his gameplan has no tools to address this type of trading,very interesting way of trading,almost risk free and almost gauranteed profit,very ingenious
 
Quote from ammo:

if that stock opens flat the next morning and he excercises his longs,yes,but he is very risk averse and his gameplan has no tools to address this type of trading,very interesting way of trading,almost risk free and almost gauranteed profit,very ingenious
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You misunderstand, the stock does not have to open flat.

Assume stock is at $42 and he has the $30/$35 bull call spread.

Assume the $35 call is assigned and the next day the stock gaps to $15. He was short the stock through the assigned call at $35 and can simply cover the stock at $15.

Assume the $35 call is assigned and the next day the stock gaps to $100. He is short the stock from $35 and he simply exercises his $30 call to cover for $5 maximum spread value.

I used exaggerated prices to prove my point but prior to expiration an early exercise is a gift horse you do not want to look in the mouth and in most cases is a good thing.

The risk to these positions is simply you need time for the spreads to decay on the JAN09 examples so as long as pick the right stocks and the market obliges you can sit on the position waiting for the returns.
 
reply to dr sean:

Thanks for the comment.

I think my answer to your question about volatility opinions is "probably not". My stock selection process (when I follow my own rules correctly) is top down. I pick my sector, and then find the best stocks I can, then find among them the few that offer good option strike selection and decent open interest. I then quickly examine the options and look at strike prices that are about 20% deep and get a quick feel for volatility.

The decision of strike selection is based on my interpretation of the chart, analyst's data, news, etc., to determine how deep I want the spread to be to feel comfortable and, finally, whether or not I can make my goal of 50% annualized yield at that depth.

The selection process is also reiterative, as one day the stock position is rejected, and the next I may want it.

So volatility is an important factor in my DITM spread selection, obviously, but not the driving force in stock selection.



reply to optioncoach:

True about early exercise, as long as your account margin can accomodate the short sale of stock. It would be nice if you could instruct the broker to exercise the long call option when the short call is exercised, but that is not an available instruction at IB. So if your margin account can't handle the short sale, the broker randomly sells your stuff till the cash is raised.

Now just suppose a very lucky guy exercises his calls on you, your broker then raises needed cash from your account to actually buy the stock needed to exercise the calls. Now you own the shares of stock AND the long calls that you haven't had time to exercise yet. Now the stock price dumps. You will have shares that you paid too much for and you have calls that have lost value. This is a nightmare scenario, not a dream come true.

So the gist is to always have enough margin in your account to handle your worst-case possibility. So I keep small positions, rather than large ones. At least till I figure out a better plan.
 
Quote from optioncoach:

If he is doing deep ITM call spreads, early exercise is a dream come true as it allows you to get the full value ofr the spread without having to wait for expiration. Think about it...
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Early exercise is almost certainly not going to happen unless there is a dividend, in which case he will end up being short overnight (with his long call) and have to pay the dividend, not to mention dealing with the IB margin liquidation the next day.

That is why I was suggesting doing these same spreads with puts, i.e. instead of buying 50c selling 55c, he should sell the 55p buy the 50p which has an identical risk/reward profile. Early exercise is less of a risk since the short put is likely not in the money.

Also I would disagree in calling this a conservative strategy.
 
your so deep in the money that you could buy a 10 cent put and even tho u give up a dime of profit u won't have the 20-30 k drawdowns
 
Quote from yucca_mtn:

reply to optioncoach:

True about early exercise, as long as your account margin can accomodate the short sale of stock. It would be nice if you could instruct the broker to exercise the long call option when the short call is exercised, but that is not an available instruction at IB. So if your margin account can't handle the short sale, the broker randomly sells your stuff till the cash is raised.

Now just suppose a very lucky guy exercises his calls on you, your broker then raises needed cash from your account to actually buy the stock needed to exercise the calls. Now you own the shares of stock AND the long calls that you haven't had time to exercise yet. Now the stock price dumps. You will have shares that you paid too much for and you have calls that have lost value. This is a nightmare scenario, not a dream come true.

So the gist is to always have enough margin in your account to handle your worst-case possibility. So I keep small positions, rather than large ones. At least till I figure out a better plan.
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If your broker does the above then you need to change brokers immediately. No broker will treat you this way with a long call protecting the short assigned stock. You have a day or two to either meet the margin required to hold the stock or simply exercise the call or buy back the stock if it tanks. All good option brokers will not put you in the nightmare scenerio you describe since you have the spread in place.

If they do, you are with the WRONG broker.

My comments on early assignment still stand. The calls have the dividends factored in and if you are assigned early prior to expiration it is a gift in most cases since you have the long call to lock in the maximum spread vaule.
 
optioncoach:
What I described is not speculation. It happened to me with IB.

I had a position in FCX, a few months ago. The short calls were exercised. By IB's rules you have 10 to 15 minutes the morning after the exercise to manually fix your account, i.e. exercise the long calls. I'm pacific time, that's 6:30 am to 6:45. I did not check my account that morning till 7:10 am. The IB computer sold a long position I had to cover the 5k shortage in my account. The position they sold was my entire position of 200 shares of stock raising about $30k of cash to cover my 5K shortfall. Now I owned 400 shares of FCX stock that was down over $2 a share from the price I had to buy the stock at. So I immediately sold the 400 shares at an $800 loss, and sold the 4 long calls at $2 less that yesterdays closing price. The stock continued to fall that morning.
This very handily wiped out any profits I made from the spread.

Also: I had to buy back the 200 shares that had be liquidated for margin, by accident I happened to make about $100 on that transaction. But this could have been a further loss.

Also: I had a taxable profit on that stock sale, that I had to pay taxes on.

Once you get bit like that, you want to prevent that from ever happening again.

But I'm not going to change over to puts. I may be wrong, but I don't like the reverse thinking. I don't like credit spreads. I don't know if the fills are as good or openinterest (liquidity) is the same.
It is a personal preference.

Now we are making too big a thing out of this issue. It is a rare event, and easily avoided as long as you scan your portfolia and protect yourself. But you certainly have to be aware of this event when you deal exclusively with DITM debit spreads.
 
Yeah IB is not the best with its automatic liquidation. But if it rarely happens not a big deal. The correct way is for the broker to recognize the hedged position but each has their own policies. Not worth changing brokers since it is rare and you know when dividends are coming up or when time value premiums have gone to nothing.
 
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