Conservative Options Strategy

Today's activity:

SOLD: 3 SUN AUG 45/50 @ 2.05 +$4.2comm
stock at 45.95, NET LOSS = 443.4
(risk management move, running out of time value, very little hope for recovery.)

Personal Note to SUN: We're done. You are banned from my portfolio. You sucked me in with your cute little P/E, your high-brow energy buddies, and your fancy 4 star S&P rating.

SOLD 4 MW AUG 12.5/15 @ 2.3
4 MW NOV 15/20 @ 3.35
STOCK AT 22.85. NET LOSS from both sales = 124
(This was simply a risk management move, got out cheap. Never should have been in this stock. Listened to CNBC, dumb. Men's Warehouse, a retail stock in this enviornment.

BUY: 5 WFT JAN09 65/70 @ 3.6, + 7comm
net cost = 1807, expected gross profit 700, stock @ 86.85
(also considred the 60/65 spread at 3.95, but finally decided on the 65/70, think the stock is strong enough)
(quick novice review: Full profit if stock over 70. Breakeven at stock = 68.6. Full loss if stock less than 65. At expiration.)



Comments on another potential pitfall:

Seeing as how we are momentarily hung up on negativity, I might as well air out the rest of the dirty laundry.
Keep in mind that the strategy is very successful when decently managed.

However. The other pitfall that requires an ounce of caution is the following scenario: You have 5 spreads of ABC stock with a 45/50 spread, it is option Friday (you went to a movie that afternoon and didn't pay attenion) and the stock closed at 49.90. So the 50 calls expired worthless, and your broker will exercise the 45 calls on your behalf. On Monday morning you will find that you are the proud owner of 500 shares of ABC stock that cost you (5 x 4500) $22500 cash money. You have to ask yourself "Did I have enough margin to cover that? Did the broker ransack my portfolio to come up with that 22.5K? What is the value of that stock right now?" If the stock is still over 45.00 when you sell it, then you still have some profit on those spreads that you have slaved over for 6 months. (This scenario is speculation, since I haven't experienced this, and don't know for sure if the broker would actually liquidate assets or simply sell the newly acquired shares automatically to cover any margin shortage. I hope I don't have to find out the hard way.)

Simple remedy, when stock price is in danger of falling below the higher strike price on option expiration day, sell the position!
 
Today's activity:

BUY: 5 SUN JAN09 30/35 @ 3.8
stock at 44.35, expected gross profit = 600
(Yeah, we're buds again. & I want my 344 bucks back.)

BUY: 5 DVN JAN09 90/95 @ 3.75
stock at 118.3, expected gross profit = 625

It feels good to be in the bull sectors. Even DITM, it would be very rough out there in the wrong stuff.

This journal could get quiet, till the market changes.
Good weekend, folks.
 
yucca-

I don't know if you are aware, but there is a function in IB (you use IB, right?) to set certain positions to liquidate last in case IB starts to sell assets to meet margin requirements. It is accessed via the account window. This can help stop IB from selling something illiquid (at the wrong time) and sell something easy, like a pure stock position.
 
Thanks swilner. Right. What would really be helpful is a "liquidate first" instruction with an algorithm that limits the number of shares to be sold as those needed to satisfy the margin.

Or, better yet - a conditional command you can set up for each short call position whereby, if exercised, you could specify the long position to be exercised with it.

In these days of computers, that doesn't sound like too much to ask.
 
I can't think of a strategy involving options that is more conservative than this one. Limited risk, limited profit, as safely DITM as you can reasonably go and still make a good yield. I could almost say, odds are in your favor, but that is only true if the sectors, stocks, and timing are favorable. Well, to that mix add in risk management and now you have a sure winning methodology, I think.

The question I ask is "Is it safer to invest long in a stock (and know when to sell it for a profit) or to invest in that stock at a level (more or less) 20% below it's present value (and capture a fixed 25% profit in six months) ?" . To me the answer is obvious, but not everybody thinks that way. I think most people feel that buying the stock is safer because short term anomalies can blow up your option strategy, and I think that is considered by most people to be conservative thinking. There is also still a lot of bias that options are for crazy people. As a test, try to explain this strategy to your mother.


Here is what I wrote on my previous thread, with some edits for grammer and clarification.
******************************************
02-09-07 09:43 AM

Here is an average guy. He has some money saved up, but not enough to turn over to a professional money manager with a proven tract record. His doesn’t trust his stock broker to handle (all) his life savings. He thinks that his retirement years may be a little lean unless he generates more income. He wants an investment strategy. Say he has a target in mind to earn an extra $1000 a month, beyond what his fixed income can generate. This extra money is not to pay the bills, but to improve his lifestyle.

So he wants an investment strategy.

a. Go to Vegas and keep doubling down on black.
b. Buy stocks and watch them go up and down.
c. Junk bonds
d. Stock Options

He chooses options. Now to select a strategy.

Here is a strategy where you win big when the stock skyrockets, but you lose if it doesn’t.
Here is a strategy where you win big if the stock moves a lot in either direction, but you lose if it doesn’t.
Here is a strategy where you win if the market goes up, and you win if the market stays the same, and you may win if the market even drops a little.

He chooses that last one, it’s called DITM Vertical Bull Spread. So what does he have to know to use it properly? He doesn't mind a little work if it leads to a better financial future, but he's not going back to college!

What are the personel traits required to accomplish his goal?
He needs will, perseverance, and desire to accomplish his goal. This is not the kind of perseverance needed to climb Everest, just the kind you need to start any new job or hobby that you want success in, and to learn the required skills.

Here are the skills and knowledge that I think this guy needs to trade DITM bull spreads successufully:

1. Learn basic computer skills, plus fast internet connection
2. Learn the basics of options, and spreads and the terminology associated with that stuff. Learn the language.
3. Learn the basic ideas behind the strategy of the DITM Vert bull spread, how it behaves as the price of the underlying stock moves, when the spread is successful, when it is in trouble.
4. Learn about expiration issues, execution issues, assignment issues.
5. Learn how to select prospective stocks. Learn the basics of fundamental evaluation of a stock. Learn how to find and use informational sources that you trust. Learn how to look at a chart, learn about moving averages, and RSI and some accumulation/distribution indicator. It is not necessary to become expert in the indicators, but looking at a chart and gathering pertinent information from it is a required skill.
6. Learn how to select sectors that are expected to show strength during the interval of your spreads.
7. Learn how to cull the stock picks for spread candidates. Learn how to select the calls (or puts) that satisfy your risk requirements.
8. Learn about diversification
9. Learn about money management, bookkeeping, position analysis factors.
10. Learn what to do when the price movement of the stock affects your spread position. Learn the decision making process to assess the situation unemotionally, and make proper decisions that will benefit your risk/reward picture. There are many choices available to you ranging from the ridiculous to the brilliant.

These issues are not, in my opinion beyond the scope of the average person to understand.
So this thread can end with the very next post. Just tell me (and any other interested parties) where a single source of information is that covers all this information, specifically related to DITM vertical spreads, and that the average person can read and understand.

I looked very hard for this information and gathered what I learned from many sources, some of which were flat out misleading. Some of them lied. Please share if you know of accredited sources to satisfy these specific topics.
*****************************************************

What I did not say, but should have is this guy DOES NOT liquidate all of the assets he has saved up and jump into spreads. He carefully acesses what portion of his savings it takes to reasonably meet his goal of $1000 per month, and that is the portion of his savings he allocates to this strategy. That is what I did. That is what the 100K I started with in Jan 06 was slated for. So my goal was 12% net return after taxes, which looked quite challenging to me back then.

What makes any strategy work is dependent on the methods (or methodology) you use to implement the strategy. And that is the goal of this thread, to state and refine that methodology with real-time (Daily) examples of the things I do (both right and wrong), and to solicit the constructive ideas from others to improve methodology.
 
yucca,

Can you list a few down fall trading options. I remembered buying a few jan. and feb. options and got creamed because the market slowed down around the period of the year; one time I had an option going up over 350%, I was overly confident and overlooked the news that the company was about to be sold to a European company, panicked, I tried to sell but there was no buyer, the option became worthless since the stock has merged with the parent company... There may be some pitfalls to options and I think it would be beneficial to know about it in advance, options however is still the better trade instrument over all.

sg20
 
Today's activity:

No trades today.

SU and WFT shares spit 2 for 1, so some spreads were "converted", no meaningful financial impact:
(of course the option symbols changed)

orginal spreads:
3 SU SEP 70/75
3 WFT AUG 55/60
5 WFT JAN 65/70

converted to:
6 SU SEP 35/37.5
6 WFT AUG 27.5/30
10 WFT JAN 32.5/35

Called IB today to find out about errors in the "average cost" column of the "Account" window, affecting "unrealized gains" figures.
The average cost of the calls of SU and WFT showed erroneous average cost instead of the adjusted average cost of the new calls. Also the average cost of GLD shows 91.96 regardless of what your real cost was (this "error" appeared about a week ago or so). Very strange. IB explained that any "corporate action" like a split or name change, etc. causes this to happen. The fix is to "right click" in the average cost field and put in the correct cost (from an old statement).
 
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