Is converting profitable directional option trades to free options inferior behavior?

D

drsteph

Is converting a larg(er) options trade to a smaller free option inferior behavior?

Example:

Thursday I went long XLF calls in March Struck at 12 (Spot was about 8.95ish) and paid $0.23 for each. For argument’s sake, lets assume it was 160, costing me $3680+commish. Rationale behind the trade was a) wanted to be long US equities exposure due to relative cheapness, b) Treasury announcement/ bailout plan expected so didn’t understand why XLF going down, c)they seemed cheap to me at the time.

Friday noted that XLF was rising hard, so decided to convert my position into a “free option.” Put in order to sell 100 of these March 12 Calls @ 0.46. Offer lifted near the end of the day, netting $4600-commish. At the moment, I was thinking that the move was too overblown too quickly, and my inclination is whenever I get a windfall profit, to take it. This leaves me with 60 XLF calls which are marked to 0.45 as of Friday. Take profits are to be at 0.72 and 1.41 for 30 calls each. Expectant profits on the trade are $1000 if all remaining calls expire worthless to about $7390 if all profit targets are hit. Risk/reward ratio on this is maximally 2.0 .

However, it is bothering me that in putting on this OTM option call play, I am essentially pricing in at least a 20% move in the XLF (10% done already) with the resultant pop in volatility giving me some additional juice on the sale of the calls. With that said, if I was willing to risk the $3680 initial charge, should I have made an all or nothing profit target of .72, which would give me $11520 profit netting me $7840. Same risk reward ratio. Also, maybe a bit easier to execute.

Any opinions here? Superficially, I think that the strategy I am executing is good money management, but suspect it may limit my profits over time. I am risk-averse by nature, and only really like to take higher expectancy trades.
 
Quote from drsteph:

Is converting a larg(er) options trade to a smaller free option inferior behavior?

Example:

Thursday I went long XLF calls in March Struck at 12 (Spot was about 8.95ish) and paid $0.23 for each. For argument’s sake, lets assume it was 160, costing me $3680+commish. Rationale behind the trade was a) wanted to be long US equities exposure due to relative cheapness, b) Treasury announcement/ bailout plan expected so didn’t understand why XLF going down, c)they seemed cheap to me at the time.

Friday noted that XLF was rising hard, so decided to convert my position into a “free option.” Put in order to sell 100 of these March 12 Calls @ 0.46. Offer lifted near the end of the day, netting $4600-commish. At the moment, I was thinking that the move was too overblown too quickly, and my inclination is whenever I get a windfall profit, to take it. This leaves me with 60 XLF calls which are marked to 0.45 as of Friday. Take profits are to be at 0.72 and 1.41 for 30 calls each. Expectant profits on the trade are $1000 if all remaining calls expire worthless to about $7390 if all profit targets are hit. Risk/reward ratio on this is maximally 2.0 .

However, it is bothering me that in putting on this OTM option call play, I am essentially pricing in at least a 20% move in the XLF (10% done already) with the resultant pop in volatility giving me some additional juice on the sale of the calls. With that said, if I was willing to risk the $3680 initial charge, should I have made an all or nothing profit target of .72, which would give me $11520 profit netting me $7840. Same risk reward ratio. Also, maybe a bit easier to execute.

Any opinions here? Superficially, I think that the strategy I am executing is good money management, but suspect it may limit my profits over time. I am risk-averse by nature, and only really like to take higher expectancy trades.
More...

You are NOT holding FREE options.

You made a trade. You earned a profit. You decided to take part of that profit and hold the remainder of the position.

Bu, you could have decided to sell the whole position. Because you kept some, that's equivalent to your investing the money you could have collected by awlling all.

It's not free. That's just an illusion. You made the decision to keep some options instead of selling. That means you invested the cash you did not take. It's a new investment. It was your cash and you chose not to take it - thus, it's NOT free. You just have one closed, profitable trade and another trade.

Mark
 
Superficially, I think that the strategy I am executing is good money management, but suspect it may limit my profits over time. I am risk-averse by nature, and only really like to take higher expectancy trades.
More...
You are correct on both accounts. You have limited your potential profits and you have executed good money management, Don't second guess yourself. You've booked a profit and you are now playing with OPM (other people's money). In reality it's your profit that you're risking but let's call it OPM :)

What you do now depends on your outlook as well as what the XLF does going forward. A possible consideration is to convert to a vertical spread. You could probably sell the Mar 13 call for about what you paid for the 12's but being so far OTM, I'm not sure that the P&L graph would be to my liking.

If your outlook is near term and not going into expiration, sell in the vicinity of 1/2 as many of the Mar 11's. That should give you more premium than you paid for your remaining calls and almost as much as your current profit being risked. That will mean little downside if wrong and a decent return if right, despite the potential of 1/2 of them going ITM.

Hindsight is 20/20 and what's best will only be known in the future. Do today what you feel comfortable with and accept the results.. and learn from them :)
 
Quote from dagnyt:

You are NOT holding FREE options.

You made a trade. You earned a profit. You decided to take part of that profit and hold the remainder of the position.

Bu, you could have decided to sell the whole position. Because you kept some, that's equivalent to your investing the money you could have collected by awlling all.

It's not free. That's just an illusion. You made the decision to keep some options instead of selling. That means you invested the cash you did not take. It's a new investment. It was your cash and you chose not to take it - thus, it's NOT free. You just have one closed, profitable trade and another trade.

Mark
More...

Belated thanks for your post, but I am not sure I agree.

I would note that if I am trading directionally (which I am), a trading decision to exit the trade is based upon my expectancy. When I put on the trade, I had expectancy that I would be able to sell the calls for double what I had paid for them. Whether they would increase in value beyond that point, I did not know, although I thought it reasonable from a probability standpoint that they would. Ergo, my decision to reduce overall risk by flattening out the trade in a ratio manner to cover costs.

In my mind, if I did not think that there was a good likelihood that the XLF would go further ITM, I'd have to be a gambler to maintain the trade. Not my style. Thus, for your assertion that I closed out the one trade and began another, it doesn't work for me as I would not have initiated a long trade at that price (i.e. bought XLF 12 C for my selling price of 0.46).

To a certain extent this is a bit of verbal self-stimulation I am indulging in, but I view it as a concious decision to risk-limit while preserving capital. I won't use that "free option" phrase any longer as I do see its flaw.

Thank you for taking the time to respond to my post.

Regards,

S
 
Quote from spindr0:

You are correct on both accounts. You have limited your potential profits and you have executed good money management, Don't second guess yourself. You've booked a profit and you are now playing with OPM (other people's money). In reality it's your profit that you're risking but let's call it OPM :)

What you do now depends on your outlook as well as what the XLF does going forward. A possible consideration is to convert to a vertical spread. You could probably sell the Mar 13 call for about what you paid for the 12's but being so far OTM, I'm not sure that the P&L graph would be to my liking.

If your outlook is near term and not going into expiration, sell in the vicinity of 1/2 as many of the Mar 11's. That should give you more premium than you paid for your remaining calls and almost as much as your current profit being risked. That will mean little downside if wrong and a decent return if right, despite the potential of 1/2 of them going ITM.

Hindsight is 20/20 and what's best will only be known in the future. Do today what you feel comfortable with and accept the results.. and learn from them :)
More...

Thanks for your opinion. Still long the XLF 12 Calls, although now profit signficiantly reduced on the remainder obviously. I'll use that theta, thanks. I might play with the idea of converting it into an ITM bull spread if XLF blows upwards and I can gague it correctly to have the spread expire with my sold call at a 50 delta. Nice idea but the devil's in the details on that one. Probably will just take my profit and move on if my expectations are met on the trade.

Regards

S
 
The cost of your calls plus the current profit is equal to the cost of taking the position today. So while you may choose not to believe that it's equivalent to taking a new position at the current price, it is. It's the same dollar risk either way, going forward. If you would not have initiated a long trade at the current price, you should close all of them.

And as for the devil's in the details of converting to a spread, it's no different than your decision to sell part of the position. You don't know what the future will bring so you look at the P&L spectrum of various adjustments and choose the one that fits your risk tolerance and reward potential. As subsequent events evolve, you continue to reassess and react, either adding, adjusting or closing.

Either way, good luck with your position.
 
Quote from drsteph:

Belated thanks for your post, but I am not sure I agree.
More...

That's fine. This is a situation that people see differently and that's unlikely to change.

You made a trade and own a position. Every day (it could be every minute, but let's keep it simple) you must make a decision.

You can add to the trade, hold what you have, or sell. If you sell, then you decide how much to sell.

Here's how I see this decision:

Any day that you decide to hold, that's the same as re-investing money into the position at current prices (without paying commissions again).

Because you can sell; because you can take your profit (or loss) at any time, holding is NO DIFFERENT from making a NEW trade at today's prices.

Thus, when you sell some - instead of selling all - you 'decide' to make the trade again (commission free), but this time you are buying fewer shares or options than you bought the first time.

It's your money. You can take it by exiting the trade, or you can choose not to take it by holding the position instead. It's your money in either case.

That's how I see it. You see it differently. It's not a big deal.

I believe the reason people see it differently is identical to the reason that some people refuse to sell a position to take a loss. They mistakenly believe it's not a loss until it's realized. They are fooling themselves. When the position you own declines in price, you have a loss. Paper loss, realized loss - it's all the same (except for taxes).

Mark
 
You must log in or register to reply here.
Back
Top