Interesting situation in an Option

nitro · Aug 30, 2003

Here is an interesting situation. What do you guys think?

I am looking at ABI.

From Option Strategist, I see that it's Percentile in IV is in the zeroeth percentile:

ABI,KGB,XCF,YIG 17 28 35 030829 36.49 600/ 0%ile

Now, from Yahoo, I see that beta of the stock is approximately 1.46.

From Yahoo, I also see that the stock has been almost vertical from March of '03, with some serious resistance at 24. However, from the same chart, the linear regression channel has been steady, i.e., not volatile, so options are "cheap" in this case is because the movement has been so "smooth." Looking at this chart, the abilty of this stock to have a three point move in the time to expiring Sept options can be done easily.

I think this stock is going to come down a bit, and I am interested in a bear call spread (vertical credit.) From the CBOE, I see that the 10 call strike expiring in Sept are selling for (11.70 x 11.90) and the 20.00 strike Sep calls are selling for (1.85 x 2.05). My intent is to leg onto this spread by eventually selling the 10.00 for a 12.00 credit (if the stock ticks up a little more) and buying the 20.00 strike for 2.00 (by buying it now.) That will give me a credit of 10.

If I am able to put this spread on, and the stock moves to say 19 by expiration. The short 10 strike which I sold for 12 will be worth 9, and the net credit from that one will be 12 - 9 = 3. The long 20 will expire worthless as the stock is at 19.

Subtracting what I paid for the 20 from my credit, 3 - 2, will give me a credit of 1 at expiration.

You can do similar calculations for the stock at 17, 18, 19, 20, 21, 22, 23, 24 etc at expirationk, but IMHO, ASSUMING I CAN LEG INTO THIS SPREAD as I explained above, this is a low risk/high reward (percentage wise) trade.

What is funny is that, in order to get into this (bearish) spread, I have to buy the call first (the cheap one) and hope the deep in the money one also ticks up - LOL. There is the directional trade rearing it's head again.

Any comments?

nitro

Hello_Dollars · Aug 30, 2003

Nitro,

If you've identified a resistance level, why not write an out of the money bear call spread with the short option at or just above that level? Then you won't be nearly as delta short and can profit under any of three scenarios (no movement in the underlying, a drop in the underlying or even a slight movement up). The trade you suggest is risky for another reason. If IV is indeed in the lowest percentile, any increase in vol will hurt you as a bear call spread is a negative vega trade. Lastly, by selling mostly intrinsic value and buying time value, the trade will likely have a negative expectancy. I'm a big fan of selling premium, but focus only on selling out of the money options (hedged with further OTM options) for that precise reason.

Regards,

HD

GATrader · Aug 30, 2003

Nitro, I agree with HD on this one. Several other things to consider. Being that the vol is in the low percentile, maybe put on away calendar spreads on the strike you think it might leak down to. Vega plus, little time decay since you are buying cal spread cheap, if stock goes down hard or leaks down u win since drop down might pump up vol, leak down, theta works better. Also try asymetric flies where given strike abc with a being the lowest maybe buy 3 c calls, sell 5 b calls buy 2 a calls, so if stocks leaks u make great, stock stays or even screams up u make little or lose little.

good luck

neospecialist · Aug 30, 2003

When I first saw your post about selling a $10 vertical call spread at $10, I thought you were joking. All your analysis about betas and volatility are irrelevant. You have no risk in the spread as it would be at its maximum value. The better question relates to your ability to time the short term-market in "legging "into your spread. If you buy the higher strike first and the stock turns down
you are merely long and" hoping and praying".

ktm · Aug 31, 2003

nitro,

I agree with HD here as well. While I don't speak Greek, my emphasis would be on expanding the winodw of profitability. As written, IF you are able to leg in for $10, you still have the costs of getting in and out plus the logistics of exercise (and you need at least a 10% drop).

The $10 call you sell is going to net you a long position in the stock over the (expiry) weekend, so you would have to sell it Monday AM at a comparable price to realize the final return. That's the only problem if you are sub $20. Above $20, you might have the $20 call to deal with too. Under .75 at expiry and exercise is not automatic. You would have to exercise the call under that level to make sure the broker doesn't leave you with just the long stock position.

Just some stuff to think about...Good Luck.

patefern · Aug 31, 2003

Neospecialist wrote:

The better question relates to your ability to time the short term-market in "legging "into your spread. If you buy the higher strike first and the stock turns down
you are merely long and" hoping and praying".

Comes down to "trading and direction" as you wrote in another thread.

Ktm wrote:

The $10 call you sell is going to net you a long position in the stock over the (expiry) weekend, so you would have to sell it Monday AM at a comparable price to realize the final return. That's the only problem if you are sub $20. Above $20, you might have the $20 call to deal with too. Under .75 at expiry and exercise is not automatic. You would have to exercise the call under that level to make sure the broker doesn't leave you with just the long stock position.

Certainly something to conceder. You're not selling any premium so a simple approach could be buying the sept 25 put and long the stock. You think the stock will drop (direction), if it does sell the stock, no uptick needed, and buy it back lower.(trading) If by some miracle the stock goes over 25 and change you make money.

Error 404 · Aug 31, 2003

Quote from neospecialist:

The better question relates to your ability to time the short term-market in "legging "into your spread. If you buy the higher strike first and the stock turns down
you are merely long and" hoping and praying".

Perfectly said.

Any spread you try to leg into becomes a trade with the same risks as any other opening position. Your anticipation of the performance of the underlying issue becomes your trade. The strategy then becomes a superfluous issue. A straight buy or sell will always be better than a spread if your predictions on price action come to pass.

As a side note, I have noticed that price quotes on the CBOE have become less and less relevant. Perhaps fine for one contract. But useless for anything more. I have left day orders out for OEX spreads recently with zero fills on 40 or 50 contract orders. Spreads have become a joke. Could have been my order room sucked (it did), but still, I would see a dollar spread (B/A) and try and buy at $.50. Then go to $.70, etc. Unless I were willing to pay the whole dollar, it is "nothing done" at the end of the day every day. In years past, I would have gotten filled on them all with a spread of a sixteenth. Now my orders just sit. I have given up on them entirely.

Peace,

RS

nitro · Aug 31, 2003

HD,

Nitro,

If you've identified a resistance level, why not write an out of the money bear call spread with the short option at or just above that level?

This is a bear call spread that is out of the money.The example you give of the stock being above below both calls strile would be an in the money bear call spread..

I need to get myself a graphing options program where I can enter these positions and it will spew out the p/l graph (at expiration) - then I can post them here. The reason I do not sell an in-the-money bear call spread is because it's p/l profile is different from this one.

Then you won't be nearly as delta short and can profit under any of three scenarios (no movement in the underlying, a drop in the underlying or even a slight movement up).

I don't understand. This spread has ZERO risk (except for comissions) _if_ the spread is put on as I explained above, _at_expiration_. At any price at or above 20 for ABI, I will break _even_. For example, at 25, the 10 will be worth fifteen, the 20 will be worth 5, and I got ten credit for putting on. At any price below 20 I start to make money, with the curve going all the way to the full credit recieved for the 10 strike, that is 10.

The trade you suggest is risky for another reason. If IV is indeed in the lowest percentile, any increase in vol will hurt you as a bear call spread is a negative vega trade. Lastly, by selling mostly intrinsic value and buying time value, the trade will likely have a negative expectancy. I'm a big fan of selling premium, but focus only on selling out of the money options (hedged with further OTM options) for that precise reason.

Regards,

HD

See my explanation above. The "only" risk to this trade is a) comissions, and 2) early exercise of the deep in the money call. In this case, even that risk is minimal as I simply early excerise my 20 call and deliver it against my 10 call.

nitro

nitro · Aug 31, 2003

GATrader,

Thanks for the idea, I will look into it.

As to agreeing with HD as to my proposed trade, I am confused as detailed above.

nitro

Quote from GATrader:

Nitro, I agree with HD on this one. Several other things to consider. Being that the vol is in the low percentile, maybe put on away calendar spreads on the strike you think it might leak down to. Vega plus, little time decay since you are buying cal spread cheap, if stock goes down hard or leaks down u win since drop down might pump up vol, leak down, theta works better. Also try asymetric flies where given strike abc with a being the lowest maybe buy 3 c calls, sell 5 b calls buy 2 a calls, so if stocks leaks u make great, stock stays or even screams up u make little or lose little.

good luck

nitro · Aug 31, 2003

neospecialist, are you a floor options trader?

When I first saw your post about selling a $10 vertical call spread at $10, I thought you were joking.

No joke.

All your analysis about betas and volatility are irrelevant.

Agreed, and so far you are the only one that caught it...

I was only mentioning it too get some feedback on a more directional trade in other circumstances.

What do you think of this sort of analysis in general to trade options directionally? If my instincts are right, you couldn't give a shit, as you probably trade on the floor and only look to offset risk as you take it, INSTANTLY.

You have no risk in the spread as it would be at its maximum value. The better question relates to your ability to time the short term-market in "legging "into your spread. If you buy the higher strike first and the stock turns down
you are merely long and" hoping and praying".

YOU GOT IT!!!!!!!!!!!!!

nitro