Conservative Options Trades

From the bottom up:

The high priced stocks are indeed very tempting to write put options on because they have such high premiums. The problem is that if you are put the stock has a very high price... that's why the premium is high. The real risk of course when writing put spreads is from the difference between the strikes. I usually write 5 point spreads but to get a positive expectation on the GOOG spread I had to make that a 50 point spread.

As I said the probability of being creamed is very low... less than 3 % but I don't want to take the risk anyway because the cost of a failure is more than I want to pay at any probability.

Every day I take a bridge over I80 between my house and my office.

http://en.wikipedia.org/wiki/Interstate_80

As I go over the bridge I can look down I80 and practically see Manhatten. The highway is 8 lanes and offers a very tempting ride into NYC. It is also loved by truckers and is full of rigs, mostly double and some triple, going 70, 75 and higher. When I have to go into Manhatten I never take that road. Just one slip and I would be creamed by the heavy rig behind me. No thanks. I take a lower speed, less popular route. If I have an accident I will probably survive. The same accident on I80 and I would be a stain washed away by the next heavy rain.

Same thing.
 
"How come it is possible to find plays with positive expected value?"

That's a really good question and I don't know the answer. You are right in that if options were correctly priced a positive expectation is NOT expected.

I spend a lot of time hunting for positive expectations and don't usually find it. When I do find it it is usually related to some recent news story and often disappears very quickly.

I have to conclude there are enough mathmatically challenged amateur investors buying options to keep me supplied with spreads.

Another thing to consider is where do I get my expectation calculation?

I get it from the distribution of prices from the recent past. The people who are betting against me are effectively betting that the news event will move the stock out of its previous price cloud and into new territory. I am betting that the price disturbance is transitory and the stock will resume it's previous price behavior.

The skill in the game is thus knowing when the market has over-responded to a news event and betting against that over response.
 
RIMM:
http://www.reuters.com/article/2011/09/15/us-rim-idUSTRE78E1QW20110915
http://finance.yahoo.com/q/bc?s=RIMM&t=5d&l=off&z=l&q=l&c=
http://finance.yahoo.com/q/bc?s=RIMM&t=1y&l=off&z=l&q=l&c=
trade:
sell the jan '12 35 call and buy the Jan '12 40 call for a net credit of $15
Yield = 15/485 = 3.1% in 124 days or 9.1% annualized
Prob = 89.13
Expectation = .8913(15) - .0755(242) - .054(485) = 13.4 - 18.27 - 26.19 = -31.06
One of many instances where I don't get a positive expectation. I could get a price reaction on Monday morning and options pricing could give me a positive expectation window but at Friday's closing prices this is statistically a losing bet. i.e. options are correctly priced.
 
Quote from danshirley:

"How come it is possible to find plays with positive expected value?"

That's a really good question and I don't know the answer. You are right in that if options were correctly priced a positive expectation is NOT expected.

I spend a lot of time hunting for positive expectations and don't usually find it. When I do find it it is usually related to some recent news story and often disappears very quickly.

I have to conclude there are enough mathmatically challenged amateur investors buying options to keep me supplied with spreads.

Another thing to consider is where do I get my expectation calculation?

I get it from the distribution of prices from the recent past. The people who are betting against me are effectively betting that the news event will move the stock out of its previous price cloud and into new territory. I am betting that the price disturbance is transitory and the stock will resume it's previous price behavior.

The skill in the game is thus knowing when the market has over-responded to a news event and betting against that over response.
More...

Excellent post! Thanks for sharing. I bet the silent readers are also/more thankful for what you have shared.

Best regards! TJ
 
Quote from danshirley:

RIMM:
http://www.reuters.com/article/2011/09/15/us-rim-idUSTRE78E1QW20110915
http://finance.yahoo.com/q/bc?s=RIMM&t=5d&l=off&z=l&q=l&c=
http://finance.yahoo.com/q/bc?s=RIMM&t=1y&l=off&z=l&q=l&c=
trade:
sell the jan '12 35 call and buy the Jan '12 40 call for a net credit of $15
Yield = 15/485 = 3.1% in 124 days or 9.1% annualized
Prob = 89.13
Expectation = .8913(15) - .0755(242) - .054(485) = 13.4 - 18.27 - 26.19 = -31.06
One of many instances where I don't get a positive expectation. I could get a price reaction on Monday morning and options pricing could give me a positive expectation window but at Friday's closing prices this is statistically a losing bet. i.e. options are correctly priced.
More...

Have you considered taking the opposite side on negative expectation plays?
 
9/15/11
"This morning, Bank of America upgraded shares of Colgate Palmolive from
neutral to buy as the company should see earnings growth over the next few quarters.
With the upgrade, Bank of America set a price target of $100 per share."

http://finance.yahoo.com/q/bc?t=5y&s=CL&l=on&z=l&q=l&c=&c=^DJI


3 income oriented trades:
1. Buy the Stock @ 93.64
2. Buy the stock and sell the Jan '12 95 call (Stock CC)
3. Buy the Jan '13 50 call and sell the Jan '12 95 call (Leap CC)

The stock will have one $58 dividend between now and Jan '12

.....................................................P/L
..................................................Jan '12

................Leap CC............................stock ........................Stock CC
cost............4040...............................9364............................8949
Price
80.18........(957) (24%).................(1288)..(13.8%)...........(873) (9.7%)

85.92........(390) (9.6%).................(714)..(7.6%)...............(296) (3.3%)

89.49.........(40) (1%)....................(357)..(3.8%)....................58..0.6%

89.86...............0............................(320)..(3.4%)...................94 1.1%

91.67..........179.80..4.4%.............(139)..(1.5%)..................274..3.1%

93.31..........343.30..8.5%..................25.... .2%..................437..4.9%

93.64..........384....9.5%.....................58..0.6%...................473..5.3%

95...............512...12.7%..................194...2.1%..................609..6.8%

100.............512....12.7%..................694...7.4%..................609..6.8%


What if the short 95 call gets called the day before the dividend??
 
tradingjournals


Registered: May 2010
Posts: 2143


09-17-11 06:21 PM



1. If he diversifies, and the hit risk is taken from the profits, there is in fact really no risk.

2. My intuition tells me that the high priced stocks are the stocks that would be good for put options writing.

Would be interesting to read any comments from Dan about my comments. Dan seems to know well what he is doing.
----------------------------------------------------------------------------------

I have always felt that when selling premium on a stock i would be willing to take assignment (in most situations). i then would sell calls till the stock is called away. A cliff note version of my stratergy.
The volatility of todays market requires that we take some heat
and knowing that assignment will be part of the game plan i then need to avoid triple digit stocks. I also adjust sometimes to avoid assigment.
I don't understand your above assumption..."the hit risk is taken from the profits"
Cheers
john
 
RAH:
http://finance.yahoo.com/news/ConAg...6.html?x=0&sec=topStories&pos=1&asset=&ccode=
http://blogs.barrons.com/stockstowa...ralcorp-has-to-make-it-work/?mod=yahoobarrons
http://finance.yahoo.com/q/ks?s=RAH+Key+Statistics
http://finance.yahoo.com/q/bc?s=RAH&t=2y&l=on&z=l&q=l&c=
Trade1:
Sell the 65 put naked with the intent of taking the stock if put and selling calls until called:
Sell the March '12 65 put for a credit of $215
Yield = 215/6285 = 3.4% in 179 days or 6.9% annualized
Prob = 58.5%
Expectation = .585(215) - .005(3797) - .41(1797) = 125.8 - 18.9 -736 = -629

Trade2:
Sell the March '12 65 put and buy the March '12 60 put for a net credit of $65
Yield = 65/435 = 15% in 179 days or 30% annualized
Prob = 58.5%
Expectation = .585(65) - .33(435) - .085(217) = 38 - 143 - 18 = -123

By my method the high volatility makes both trades ill advised but the spread is considerably less ill advised because of the cap it puts on possible loss. Also note that the naked short put requires margin of 6285 while the spread requires margin of 435... and the correspondingly huge difference in 'black swann' liability.

While the high volatility makes the trade very unpredictable the calulation does show why I prefer to use spreads over naked short puts.

Actually I think RAH is a really good stock and I am interested in taking RAH as a holding whether or not I sell calls on it and I might in fact take trade 1 (maybe at a lower strike)... but that's outside of my 'conservative option trade' methodology and not a trade I would usually post in this thread.
 
Dan: with regard to the loss paid from gains, what I meant is that if the chance of a big hit is small, by the time one gets the hit (if any) the account would have compounded enough that the loss from the hit would hopefully be only a fraction of the gains one would have made. There is of course the bad luck that one might get hit even on the first trade. I guess it is the reason why one needs money management, and diversification.
 
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