Improved? Conservative Options Strategy

I don't think you get it! The purpose of this thread, what I'm discussing, what I want to accomplish. So I'm using this post to explain it to you.

My thoughts. This is not the right forum to do this. But I don't know of a better forum to go to. Very few people come here anymore to learn anything, I think

Obviously I don't know all of you so I'm speaking about the overall impression of this board. I know Optioncoach has shared a lot and mentored a lot. Ammo has a generous heart. Atticus wants to help and could be teaching at graduate level, but no newby can understand him. There are plenty of others who have shared over the years, and plenty of others who just sneer and growl.
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Why doesn't a board of this size have a newby forum? Where are the tutorials posted that give newbies a clue about how to survive in a screwed-up market that has undergone a generational trauma. Where have all the newbies gone since the beginning of 2009? I guess they go to forums that sponsor information training for a fee, that have guys that sound like traders who will answer their tedious questions with canned chatter. Where do they find experienced traders/investors who have a little time to steer them correctly? I hope they have an uncle.

What I say next is a rant about the economy, but it is only in this context that this thread is here for a little while. Without this context, this thread is just silly. So this thread is born out of the ashes of the markets of late 2007 through March 2009, as I've said. I barely survived it, and documented the entire experience on this forum. But I did survive it and recovered. Not everyone has recovered. Not every one who needs a job has a job, and a thriving nest egg, and confidence in the future. We have a market that is still below the “crash” we thought was occurring in 2008 when the market (S&P) went below 1200 from 1560. There was much wringing of hands and news of a Bush bailout, and a major bank failure. We didn't realize it was just beginning to crash – that it wouldn't stop falling till the S&P went to 670 pts. So the American public has a stock market that is propped up by the debt of future generations, not enough jobs, a huge loss of equity in our homes, no clue how to invest for the eventual recovery, news reports about a second recession late this year, a world full of religious wars, CDs, bonds, treasuries that pay next to nothing, and we are bombarded with ads to buy gold. We have learned not to trust stock brokers, or mutual funds, we keep an eye out for wannabe Madoff's. How do we invest? Do we have to become daytraders, who seem immune to the vagaries of the markets? We want to learn something about how to survive and invest, but we don't even know what we want to learn.

So out of the universe of how-to books, plans about gold, investment ideas on forums and in the news, here (this thread) is another of the thousands of ideas about how to invest. People hear about options all the time now. They even have shows on CNBC about how “savvy investors” and pros use options all the time.

The strategy I want to talk about here is simple, a vertical bull spread. It is laboriously discussed in options books that dedicate from ½ page to as much as 2 whole pages on the subject. It's just too simple to talk about. The books want to discuss iron condors, calendars, delta neutral, butterflys, stuff you can really sink your teeth into. This is too simple, anybody can understand this. But WE all know it's not so simple. WE know the strategy is a tiny fraction of what an investor has to know to make it work. WE know it is all about how the strategy is implemented, considering market conditions and timing and stock selection and timing and technical tools and timing any money management, that makes up a methodology that can be successful. So, not so simple after all. But too much for an average motivated guy to understand? I don't think so.

So we talk like there are bull markets and bear markets and there are strategies for each of them and the smart guy can always tell when one starts and the other begins. No big deal. Well I'm an average guy and what I see now is a market that does whatever the hell it wants to, whenever the hell it wants to. We may or may not find out why it did it at some future time. Thats not the way a “normal” market works, maybe, but it is the way this present market seems to behave. The way I want to invest (with my view of the market) is to use a bull call strategy that is in the money, for safety reasons so my investment can handle a little market fluctuation, and the deeper I am in the money, the more safety net I have. My view of the market is that either we all die and/or at some future date the economy will recover. Months, years, I don't know. I can't wait. I'm old and I don't like sitting on money that is slowly becoming worth-less because of things I have no control over. So what is that view – bullish?
So with that view, long-term option investments sound more logical than short term option strategies.

As I've said, I like this strategy and have used it through thick and thin, easy times and hard times. I've made mistakes, all in public view, and I've learned, but I've always tailored the spread to my view of the market. The structure of the bull spread I'm proposing now is different from the way I structured it before, but it is the same ole DITM Vertical bull as always.

So if you share some of my views, maybe you want to read about how I invest, and if you don't – thank you for visiting.
 
I missed your 1st journal, and am now starting to read it.
This whole strategy is interesting. Did you work out the theoretical probability that FCX would be at or lower than the spread at some point between now and the spread's expiration in 2012, and if so was this less than 50%? I actually ginned up a spreadsheet for this a while back for my own stuff, but it only goes out 90 days. I guess just for my own curiosity I'll have to extend it out.
As a passing thought, doing this on FCX seems a bit dangerous to me. But the reward does have to come with some risk, I suppose.
 
interesting journal...being a fellow options trader Im always on the lookout for different strategies, I am by no means an expert but always willing to learn. Anyway, couple of quick questions
Greeks?
You are obviously looking to be theta positive on your spreads, but then what you describe in the stocks you look for, are you looking to be as delta/gamma neutral as possible?
Also, why are you looking for high volatility stocks? It seems you would want the opposite since you don't want to worry about market swings. Or are you always buying at low volatility hoping to gain from an increase in volatility as well?

Do you ever hedge your portfolio against the S&P or another sector/stock? It seems you have no real downside protection other than time.

Good Luck with your trading/journal.
 
trefoil: To answer your question: with reference to FCX JAN12 40/45 @ 3.2, 56%.

I have no clue how to calculate theoretical probability that FCX would be at any value, and if I did have that algorithm I sure wouldn't trust it enough to trade by it. I got into that spread at one of the recent stochastic lows – maybe in early june when it started climbing out of a long decline, but probably in early july when support was confirmed in my eyes. So I got a good price. As luck would have it there has been a large climb since and the spread is now worth close to 4.0. I just may put out a gtc (good till cancel) order for 4.3 or 4.4 and see if it hits. Remember my goal is to hit 35% annual yield, if I exceed that early why not exit? If not I'll just hold onto it as long as it doesn't break the support at 60. So that is pretty much the rationale there. That support has held since Aug 09.

You are right that it is a risky stock, so I only have 2 to 3% (max) of any portfolio behind it. Lets suppose I broke my rule and jumped in now. To get a $3.2 spread now at the higher prices, I'd have to go to a Jan12 55/60. No way. I'll wait for another market low if I want to add another FCX position.

Why this stock? Why not JNJ, good conservative low-beta stock. Stock at 60. P/E about 12, I see support at 55 eyeball. So the stock is near support and almost touched it recently. I don't think I would consider a 45/50 spread as safe as a CD. Maybe a 40/45. But at today's prices a 45/50 spread would cost about $4.2 (for a profit of .8 in 18 months) and a 40/45 spread would cost maybe 4.5 or even more. I don't know what to say – mathematically the odds are built into the option pricing, but I don't always agree with the odds. And I can't tell you exactly why, and my reasons are not what you would use anyway to decide how you would implement a strategy like this.

Another quick thought, the survival rate of spreads of such long duration to last till expiration would be almost nil. If you look at a typical chart of this type of spread (which I do rarely), I think you will see that by the time half the spread life has expired, somewhat more than half the time-value will have accumulated, given a constant stock price. I'll plot that out and check that when I have time to relearn how to use that software. If I have months left till expiration and have 65 to 80% of my max profit, that spread is history. And if the price drops and the fundamentals or technical outlook is not so good, it's history. Now if the price drops and the stochastics indicate an oversold condition, and I have plenty of time left on the spread to wait out a recovery, I would probably hold on rather than take a loss. In that latter case I would hope that I have the guts to dump the spread when the expected recovery becomes less likely. If you have long term spreads, it is nice to have the time to let things work out. You do not have that luxury in a short term spread.


Now to tlow's comments:

It may be obvious to you that I'm looking for theta positive, but to tell you the truth I have looked up the definition of theta a half dozen times and forgotten what it means just as many times. It just is not relevant to the way I trade, same with gamma (is that the derivative of delta?). I don't care what the rate of change in delta is. Now I must admit to an interest in delta and beta because they really are relevant to my selection process. If you read what I wrote so far, you should already have a good idea of my selection process. (I like to think of it as common sense, others describe it by less friendly terms.) Now, I put in this post an example of why, rightly or wrongly, I like high volatility stocks (like FCX over JNJ). I can't prove this but my instinct and experience leads me to believe that the low beta stocks are over-rated by the options pricing calculations, such that the delta between strikes is too low to represent the real world risk. I hope that sounds halfway intelligent, even if nobody else feels that way. Again I repeat that how I select stocks and select spread strikes is not what I hope you will pick up. I hope rather that you understand what I do so you can see my “flaws” and work out for yourself how to better implement what I think is a terrifically flexible way to invest. I think my good ideas are in the first post, and the details like what are in this post, simply are food for thought. Does that make sense?

You also ask “are you always buying at low volatility hoping to gain from an increase in volatility as well?” I think my answer is yes. When prices are low, volatility is generally low, so spread prices are cheaper. And vice-versa, like how the spread value has so quickly increased in my FCX position because of the price gain. But the flip side to that is when you guess wrong and prices drop even lower, this works against you. So all this means is buy low and sell high. I use stochastics and support to find my lows and hope that the odds are in my favor by doing so. Mostly it seems to work, not always. Another of the virtues of long-term spreads is that prices are not so sensitive as short-term options and if you miss the bottom by a couple of bucks, you won't get hurt too much when you buy the spread.

Another question you had: “Do you ever hedge your portfolio against the S&P or another sector/stock? It seems you have no real downside protection other than time.” Wow! When I recall all the trauma in my last thread about this. We endlessly went round and round, with “ammo” (who was never wrong) working so hard to get me to use puts or something, anything to hedge my positions. By that time, the horse was already out of the barn. So I'll paraphrase to you what one of my books on options said about bull spread protection; “It's up to you, dude.” My conclusion is why hedge a hedged position? Just exit the position when it no longer works for you. There are plenty of fish in the sea (maybe not the Gulf), and there are endless future opportunities to get into better positions. Don't roll the spread, don't spend more money on it, just get out. As a rule (that I have already, in this thread, admitted breaking), I also say don't leg in this and leg out that – it's too risky. We bought the spread because of a set of conditions and when they no longer apply, just sell the darn thing. ( God, I wish I was this smart in 2008!)

As to your point about worry about market swings. Two ways to handle it – low volatility stock or going very DITM.

Hey guys. I promise I won't so long-winded on every question. Don't let this scare you off.
But/and, I also have no intention of posting too frequently.

Last thing! The few example spreads I listed are not all my positions. I have many other positions that I will post soon. No big hurry since they are long-term and it is like watching grass grow. But this is supposed to be a journal so I should list some positions and tell you how they work out if there is interest in that and I can keep the thread going.
 
Quote from yucca_mtn:


When prices are low, volatility is generally low, so spread prices are cheaper. And vice-versa, like how the spread value has so quickly increased in my FCX position because of the price gain. But the flip side to that is when you guess wrong and prices drop even lower, this works against you. So all this means is buy low and sell high


As to your point about worry about market swings. Two ways to handle it – low volatility stock or going very DITM.
More...

Yucca,


I think if you did a bit of reading up on the Greeks that could help your trading a lot. When you say prices are low, volatility is low is not necessarily true. As a general rule of thumb as the stock goes up, volatility goes down. For your FCX spread, I can't tell exactly why it went up without knowing when you entered the trade...but I am willing to guess you got some nice delta gains because the stock has been on the climb lately...not necessarily due to the increase/decrease in volatility.

I always like to point out to people don't forget about the greeks because they can make/break your options trades. As an example I always point out earnings...you could have a long call and the stock crushes earnings and bounces up 10% after earnings but your call actually loses money. That is due to the decrease in volatility. You made delta gains but the loss in volatility wiped all those delta gains out. With regards to spreads, you are little more protected because you are selling volatility on one leg...but if the skew between the long and short leg collapses, you could lose a good deal even on a spread.

I think it could also help you choose a better spread, not saying yours are wrong, but you may be able to make more with playing around with different strikes, wider/narrower, spreads, etc.

Finally, in regards to market swings...if you were hedged or had some downside protection, you may not be down as much due to the 2008 drama...what if that were to happen tomorrow? You probably would be down even more money.


Hope that helps.
 
from tlow.

"I think it could also help you choose a better spread, not saying yours are wrong, but you may be able to make more with playing around with different strikes, wider/narrower, spreads, etc.

Finally, in regards to market swings...if you were hedged or had some downside protection, you may not be down as much due to the 2008 drama...what if that were to happen tomorrow? You probably would be down even more money."

If you are not finding a problem with the spreads I've posted, why are you saying I could find better spreads? If it ain't broke, don't fix it. Find a problem, them we'll talk.

It is my opinion, and mine alone, that putting on "hedging" positions are new positions that should be entered because they are in keeping with your market strategy, and they stand alone on their merit. As I said my positions are inherently hedged, and I've touched on an example (the Gulf crash) earlier of how some positions were harmed, but not seriously so. So my market view is my positions are pretty solid, when I don't feel that way I'll do something. I'm not going to put on bear spreads on the spy now cause I don't think it is the right thing to do for my portfolios.

You invest your way, I'll invest my way and I'll never say otherwise.
 
No worries man...just my 2 cents. What I was getting at with finding better spreads, maybe you can and maybe you can't...I can't do the work for you since its your strategy and like you said you are going to trade the way you feel is best. Personally, I do a lot of broken wing butterflies (BWB), straight calls and puts mainly. I spend a lot of time playing with strikes/spreads/no of contracts/etc and I find it helps maximize my profits. IE was it better that I put on the BWB or should I have just bought the call/put outright? So for your FCX spread as an example, if you were to close it today, in hindsight, would have still bought the same spread? And now that FCX has made that move do you still feel that is the best spread to have?
 
tlow Thanks for your comments. Using my best hindsight I have to say I would have bought the exact spread I did, but I would have bought MORE of them. Hindsight also says I should have bought a bunch of otm august calls. Seriously, I followed my plan and I wouldn't change a thing. No way to know the future.
 
This is a list of more of my spreads. The ones with a star on the right indicate older positions that have been lower than my cost at some point (mostly because of the Gulf crisis) but I felt it was better to hold them than take the temporary hit of up to 20%. They look better now. Most of the JAN12 spreads were put on during the lows of the Gulf crisis.

I have not added any positions since early July when stochastics were low. The only trading I've done since then is use the bounce on Aug 2 to sell many spreads, in a number of portfolios, to get rid of the most risky positions on a really good day, where I was able to very closely brake even. These were all spreads that were underwater to some degree until that strong day brought them up enough to exit safely. It was a very good day, like sucking all the infection out of a wound! And I raised lot of cash to take advantage of the next buying opportunity. It was a very busy day with little time for documentation. I had no concerns at all that with six months till expiration, better days might be coming. The spreads I sold were no longer as DITM as I like, now they are history.

Please keep in mind, the spread positions I hold are 30 to 35% of a portfolio.


Note: Of course these are all DITM Vertical Bull Call spreads. Position size varies.

UNDERLYING EXPIRATION LONG CALL SHORT CALL COST

PKX NOV10 80 85 3.55
AGU JAN11 50 55 3.6 *
APA JAN11 80 85 3.75 *
CF JAN11 50 55 3.8 *
EWZ JAN11 45 50 3.6
FCX JAN11 60 65 3.6 *
FCX JAN11 50 55 3.25
GDX JAN11 33 38 3.8
GDX JAN11 30 35 3.4
GDX JAN11 30 35 3.57
GLD JAN11 100 105 3.3
GLD JAN11 100 105 3.8
GLD JAN11 90 95 3.4
NEM JAN11 30 35 3.8
OXY JAN11 65 70 3.3 *
PAAS JAN11 17.5 20 1.3
SLB JAN11 40 45 3.75
SLV JAN11 10 15 3.3
XLE JAN11 41 46 3.75 *

AEM JAN12 45 50 3.1
CF JAN12 45 50 3.05
COP JAN12 40 45 3.2
DO JAN12 45 50 3.2
DO JAN12 45 50 3.58
EEM JAN12 25 30 3.6
EWZ JAN12 50 55 3.1
FCX JAN12 40 45 3.2
RIG JAN12 35 40 2.75
SLB JAN12 42.5 47.5 3.1
 
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