Conservative Options Strategy

Quote from yucca_mtn:

The commission structure you mentioned did exist, but it was a little more daunting to a newby (like me) than you imply. That type of commission structure and like Optionetics too (I think) was not friendly to a small player just starting out with a small account to play with. It forced him to be a little less DITM than I strive for, and it favored a larger position than he would be comfortable with, and it discouraged diversification, and it affected his management decisions too much. All this made DITM spreads a lot riskier and much less desirable than they are today. And I think not so suited for small investors as this strategy is today. Anyway that was the point I hoped to make.

Sure Pros had the commission structure to put on these DITM spreads. I kind of doubt that their investment goals and management style would fit a small investor like me. They aren't the "retail" crowd I was talking about.

Also, coach, you imply that the DITM Vertical Bull acts like a covered call. "you are buying a deep ITM call which can act as a replacement for a long stock position and selling a short call against it." I've heard this before and I see your point, but I can't agree. I maintain that the DITM vertical bull spread is not like a covered call, or an OTM vertical bull spread, or like any of the other ITM,ATM, DOTM vertical bull spreads. The methodology is just very different for each type. I don't think you can manage a DITM bull spread like a covered call, or any other kind of spread. The different types of spreads all have different investment goals, different stock selection criteria, different entry and exit requirements, different risk tolerences, different management choices. And more.

For the record, I did not, and Columbus did not, discover this strategy. However, I think I am striving to develop or least improve on, a proper methodology for a very specific type of spread, through trial and error, and experience, without a huge amount of support from literature or peers. I may also be full of beans.
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Well no commissions were friendly to one lot option traders but the commissions are not the reason this strategy could work now and not then. Your profits are just higher because the cost of doing business has dropped nicely.

Well to be fair I did not say it is like a coverd call exactly, I said it is different in that you dont have the risk of the covered call position since you are using an ITM call as a proxy for a stock position.

But the ITM call spread IS identical to the OTM put spread, one is a debit and the other is a credit. And you may not realize it but I could probably find tons of books on selling OTM put spreads on stocks to collect premium and income. Those without any familiarity of synthetics might not have realized that it would be the same thing as buying the DITM bull call spread.

The way to manage it has nothing really to do with the spread but in your stock selection and research. After all from what I have seen you are not managing the position itself but simply determining when to take profits or bail solely on movement of the stock. But you have a whole word of choices when you see that DITM bull call spreads could be converted to credit FLYs or small debit condors or ratio spreads or Christmas Tree spreads or a few other adjustments.

The strategy is meaningless, it is how you select your stocks and determine when to bail on losses or take profits that matter. If you feel there is not a lot of literature on deep ITM bull call spreads then maybe you are not seeing someone spell out the exact time and place to put on the position. But I assure you there is material on Bull Call Spreads and Bull Put Spreads as well as Covered Calls and Diagonals which not exactly the same still give you the idea of ways to manage the position.

The spreads do not have different investment goals, different stock selection criteria, different entry and exit requirements, different risk tolerences, different management choices. You are the one that supplies all that to then select the right strieks and time frame to match your assessment.

We are here just to help given our collective experience. Once you understand the basics of the strategy you are employing and read all the information on bull call spreads and bull put spreads you then can simply adapt it to the specific strike selection criteria you have chosen, which happens to be deep ITM.

I think I remember reading Fontanills and McMillian talking about the beauty of ITM call spreads so that you make money if market goes up, sideways or down to an extent. It has been written about a lot so you can certainly learn all you can to use it to your own advantage ot make money.

So bottom line and this was long-winded, do not try to reinvent the wheel. Lots of us can help cause we have been where you were.
 
Thanks to atticus and optioncoach for their input.

To optioncoach: I agree with everything you said in your last post. About synthetics - (short response cause I have to go) Like you said there are many ways to tweak a spread to make it work better. My problem with put spreads is only this - It is intuitive to me how to proceed if I want to convert a 70/75 bull spread to a 65/75. It is easy to figure costs, and profit potential, and to spot the situations to make such a manuever attractive. To me - it is not intuitive how to do that with a put spread. It is as simple as that. It is a flaw, maybe. I'll work on that.

atticus: I do expect the pros to "roll over in glee". This thread is probably like saturday night live to them.

Intended audience - guys like me.
 
Quote from yucca_mtn:

It is a flaw, maybe. I'll work on that.
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No need to work on a flaw. If you are more comfortable with call spreads then stick with what you know.
 
Quote from yucca_mtn:

atticus: I do expect the pros to "roll over in glee". This thread is probably like saturday night live to them.

Intended audience - guys like me.
More...

;)
 
Look, I love my DITM bull call strategy. I do not want to change it unless there is a really REALLY good reason for doing so. On the other hand – it ain’t fun having your very best positions begin to take on the aspects of the enemy.

You get lucky and you put on a spread and the stock shoots up, just like in the movies. This means your position has done what you hoped it do. Now your position is supposed to be safer because it is deeper ITM, and you are more protected from a sudden price drop in the stock. That is supposed to be a good thing. But then the stock gets so deep ITM that the possibility of an early exercise starts to look very ominous. Now the wonderful position you were so clever to buy starts looking very dangerous to your portfolio.

Contributors to this thread have beat me about the ears with the news that bull credit PUT spreads do not have the danger of early exercise. My response has been “I don’t like puts!”.

But suppose I can convert only those bull credit spreads that are dangerously DITM (considering early exercise) to put credit spreads. I think I might have the best of both worlds. When the call spreads get too deep, I sell them and replace them with put spreads. The put spreads are so DITM that there is little need for fancy position moves. So I don’t have to break my head trying to figure out synthetic defensive moves. I just sit there and let them expire worthless.


But consider the following real-world example (figures right now):

Right now I have this position: 8 CNX OCT 55/60 @ 3.8(cost)
The stock has risen about $20 per share since I bought the spreads. The long 55 calls are at 45.30 and the short calls are at 40.85. Since the 55 call is at 40.85, I’m at risk of early exercise, and my account would need about (40X800) $32,000,00 margin to protect me from that event. So the spread is worth about 4.45 current value. So I can probably sell it for 4.35 to 4.4. It seems a shame to take a beautiful spread like that and only make .6, and sell it early just to avoid early exercise.

The bid/ask on the put spread: CNX(Puts) OCT 55/60 is bid=.36, ask=.65. I can sell it for .45 probably.

So if I make this move, I get 4.4 for the call spread, and .45 for the put spread, a total return of 4.85. A very nice return on my 3.8 investment AND I don’t have to worry about early execution for those next 4.5 months. My account cash value will change, but my margin and available funds should be about the same as before the swap, right?

So what do you think? Is this old dog learning a new trick, or just barking up the wrong tree? Any better way to play this?
 
You need to talk to your broker and find out why you need that kind of margin if assigned early. You have a spread and the long call can be exercised to cover the posiiton at maximum spread value.

The brokers I am familair with have no problem with you getting assigned on the short call because it is hedged completely.

I will repeat what I said before, if your spread is DEEP ITM and you get assigned early on your short call it is a perfect scenerio. If your broker does not allow that then you need to talk with their margin department and educate them. This is basic option information which any option broker should understand.

There is no bad risks with early assignment if your spread is deep ITM. Simply exercise the long call when you are notified of assignment and position closed.

Early exercise is not a major risk to avoid doing DITM call spreads. Like I said stick with call spreads if you like them but talk to your broker if they appear to be clueless on option spreads and how they work.
 
Quote from yucca_mtn:

Look, I love my DITM bull call strategy. I do not want to change it unless there is a really REALLY good reason for doing so. On the other hand – it ain’t fun having your very best positions begin to take on the aspects of the enemy.

You get lucky and you put on a spread and the stock shoots up, just like in the movies. This means your position has done what you hoped it do. Now your position is supposed to be safer because it is deeper ITM, and you are more protected from a sudden price drop in the stock. That is supposed to be a good thing. But then the stock gets so deep ITM that the possibility of an early exercise starts to look very ominous. Now the wonderful position you were so clever to buy starts looking very dangerous to your portfolio.

Contributors to this thread have beat me about the ears with the news that bull credit PUT spreads do not have the danger of early exercise. My response has been “I don’t like puts!”.

But suppose I can convert only those bull credit spreads that are dangerously DITM (considering early exercise) to put credit spreads. I think I might have the best of both worlds. When the call spreads get too deep, I sell them and replace them with put spreads. The put spreads are so DITM that there is little need for fancy position moves. So I don’t have to break my head trying to figure out synthetic defensive moves. I just sit there and let them expire worthless.


But consider the following real-world example (figures right now):

Right now I have this position: 8 CNX OCT 55/60 @ 3.8(cost)
The stock has risen about $20 per share since I bought the spreads. The long 55 calls are at 45.30 and the short calls are at 40.85. Since the 55 call is at 40.85, I’m at risk of early exercise, and my account would need about (40X800) $32,000,00 margin to protect me from that event. So the spread is worth about 4.45 current value. So I can probably sell it for 4.35 to 4.4. It seems a shame to take a beautiful spread like that and only make .6, and sell it early just to avoid early exercise.

The bid/ask on the put spread: CNX(Puts) OCT 55/60 is bid=.36, ask=.65. I can sell it for .45 probably.

So if I make this move, I get 4.4 for the call spread, and .45 for the put spread, a total return of 4.85. A very nice return on my 3.8 investment AND I don’t have to worry about early execution for those next 4.5 months. My account cash value will change, but my margin and available funds should be about the same as before the swap, right?

So what do you think? Is this old dog learning a new trick, or just barking up the wrong tree? Any better way to play this?
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What about a one day loan at prevailing rates to fund the exercise untile the long is sold?
:D cheers
john
 
Today’s activity:

I did what I threatened to do in my previous post. Stock at 99.2.
My original position was; 8 CNX OCT 55/60 @ 3.8 cost

I sold: 4 CNX OCT 55/60 @ 4.40, net profit 233.0
I sold: 4 CNX OCT (puts) 55/60 @ .45,
( net profit (400 X .45) – 5.6 comm = 174.4), if the spread succeeds.

So now I have 4 bull call debit spreads, and 4 bull put credit spreads on the same position. For comparison. And my head only hurts a little bit.

For the rookies, here is the deal with bull put credit spreads:
I am short the 60 put, so the owner of that put can make me buy 100 shares of his stock for 60 per share, useful only if the price of the stock drops below 60.
I am long the 55 put, so I have the right to make somebody buy my 100 shares, (that I just paid 60 for) for 55 per share. So if both of those put options are exercised, I loose $5 per share, and that only happens if the CNX stock goes below 55 per share.
Yes, I know, clear as mud.

So now I’m going to sit on the egg till it hatches, or till the egg cracks, whichever come first. Yes, I jest, but I really hope this ploy works out because it really could alleviate a rare but serious concern, and make my vacations a lot more worry-free.


John – Thanks, I see you’re going to be a big help. So I call you for the loan?
 
Quote from yucca_mtn:

Today’s activity:

I did what I threatened to do in my previous post. Stock at 99.2.
My original position was; 8 CNX OCT 55/60 @ 3.8 cost

I sold: 4 CNX OCT 55/60 @ 4.40, net profit 233.0
I sold: 4 CNX OCT (puts) 55/60 @ .45,
( net profit (400 X .45) – 5.6 comm = 174.4), if the spread succeeds.

So now I have 4 bull call debit spreads, and 4 bull put credit spreads on the same position. For comparison. And my head only hurts a little bit.

For the rookies, here is the deal with bull put credit spreads:
I am short the 60 put, so the owner of that put can make me buy 100 shares of his stock for 60 per share, useful only if the price of the stock drops below 60.
I am long the 55 put, so I have the right to make somebody buy my 100 shares, (that I just paid 60 for) for 55 per share. So if both of those put options are exercised, I loose $5 per share, and that only happens if the CNX stock goes below 55 per share.
Yes, I know, clear as mud.

So now I’m going to sit on the egg till it hatches, or till the egg cracks, whichever come first. Yes, I jest, but I really hope this ploy works out because it really could alleviate a rare but serious concern, and make my vacations a lot more worry-free.


John – Thanks, I see you’re going to be a big help. So I call you for the loan?
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Its a collateralized loan with your port. as security.why wouldn't
someone at IB (i have an acc. there also) look at this? whats the downside ?
It beats the disruption an exercise on a fully invested port. have and they pick up the interest .
I might be out of my league here:D
cheers john
 
Think it’s easy writing a journal where 90% of your readers have 10 times more experience than you do? However, I think my trading is going to benefit a lot from this thread (I’ve already learned three things that will affect my decisions.) I hope it benefits someone else.

Today’s activity:

I sold: 4 CNX OCT 55/60 @ 4.45, net profit 253.8
I sold: 4 CNX OCT (puts) 55/60 @ .42,
( net profit (400 X .42) – 5.6 comm = 162.4), if the spread succeeds.
(Converting call spreads to put spreads, almost same deal as yesterday, same reasons. I liked it.)

SOLD: 7 GLD JULY 97 @ 0.3, comm.=4.9
Expected gross profit = 210
(these OTM calls are covered by my long GLD. Purpose: make enough to cover margin costs (interest), but don’t want the GLD called away.)

BUY: 5 GLD DEC 75/80 @ 3.65
ETF at 86.6, comm.= 7, expected gross profit = 675
(so options recently were offered on this ETF. Not sure how I feel philosophically about the wisdom of leveraged gold, but I’ll take advantage of the situation, and smarter people than me think it’s ok. I am still bullish on it, so not as DITM as I usually want to be.)

****************
Now I’m beginning to see that the conversion from call spreads to put spreads is not universally helpful, but it works in some circumstances. (like with CNX.)

For example, I recently bought 8 CF NOV 85/90 @ 3.95 when the stock was 135.5.
Today, the same spread is @ 3.8 and the stock is 148.7. So my spread has lost (paper) value even though the stock has risen by $13. Volatility increased. Anyway, the spreads were DITM when I bought them and even more DITM now, so I considered converting them to put spreads also. Didn’t work in today’s market.

Now (as I write this) I can sell my spreads for 3.75, and sell put spreads for .8. That would give me a max return of 4.55, compared to the 5.0 that is now possible. In a true synthetic, the put spread should be able to sell for 1.1 if the call spread can be bought for 3.85, giving .05 to the option brokers for each option.

This again confirms what I had found in earlier days, that I seem to be able to get better debit spread fills than credit spread fills. I assumed at the time that this is because calls were more frequently traded than puts, but that could be a wrong assumption. And at different times this may not be a fact, in a dynamic market.

I think if I continue to monitor this possible trade, I will sooner or later find a time when it does work to my advantage to convert the CF position. There is no rush since there is no immediate reason for early execution.

(The numbers have already changed as I’ve been writing this.)

**********
Along the same line of thought, I did not actually "convert" call spreads to put spreads on the CNX position. I closed out a position and I opened another position.

Each one of these two trades should be able to stand on it's own merits. Selling the put spreads at $42, meant I was putting up $458 to back that spread. That means I was initiating a spread that would earn 9.2 % during the next 4.5 months, an anualized yield of 20.4%.

A rather low expectancy. But I gained benefits from the trade that I deemed satisfactory - elimated risk of early execution, captured some realized profits, did not drain more resources fom my account than was already tied up. Time will prove me right or wrong. I do not generally advocate this risk/reward profile. So I'm still considering the merits of this trade.... Would it have been smarter, for example, just to close it out and commit the funds to my standard DITM spread profile?

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