Methodology of the DITM Vertical Bull Call Spread

Quote from yucca_mtn:

URSA - what is FA? Something about position analysis I assume?

Just for fun here is a thought, since you brought up bear spreads.
The Black-Scholes equations are used to calculate the value of options, I gather. Big computers, very smart algorithms, almost god-like.

If they are so smart, do they take into consideration somesort of factor for future expectations of the companies' outlook? Or general market conditions? Logically they must don't you think? How else can they judge the value of an option?

Now delta is a spin-off calculation based on option pricing. And delta is used to help determine the odds of an options resulting gain or loss.

So what if the market expectation for a particular stock is downtrending. A guy would short the stock, right?
But the option pricing just goes along pricing options in the future always higher with increasing time.

If a stock is trending down, for a significant time, and the the may option ATM for that stock is $7, wouldn't you expect the July option to be less? But it never is.

So what is the implication of that apparent anomaly for bear spread option traders? Huh?
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FA=Fundamental analysis.

Since you said you were bad at stockpicking but also that you used FA as a basis for choice I assumed you do a 'best estimate of the future' direction. That's a ok strategy in itself. Using bull spreads for that is also ok, if you like them, but then you bet on time passing to give you profit.
After I understood that you had 50 positions on I really wondered how you did 50 FA's. One FA is a lot of work as far as I know, but I don't know much about it, don't believe in it myself.
Well, anyway, since you have 50 different positions on and your biggest risk is a market tanking, why not choose about 50% of the stocks (with FA) that are expected to fall, so you can put on a bear-spread. When the blackswan comes by half you position will win, not enough to cover the losses, but everything helps.

Sorry, to say, but your story has a lot of holes and I really feel you don't know what you're doing. You're peptalking to yourself, as is good Fontanilles tradition, but it won't change realilty. Also I don't like your disdain for those who had the patience and the brains to study the theory behind this wonderful phenomenon called options.

As MTE and coach are telling you, it is just another strategy, equivalent to a bull put spread, or a covered call with a put below for hedge. It's all the same and if you ignore that fact you're fooling yourself. There is no magic in moving the strikes DITM, your r/r will be the same as when you would do them OTM or ATM. You get what you pay for.

Ursa..
 
Quote from yucca_mtn:

And where is your source of study on Black-Scholes theory...that market conditions are irrelevent in pricing options?
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Because any option can be turned into a synthetic of exactly the opposite position.

Let's say you were right, and a stock in a downtrend is now discounting ATM calls several months out. This would imply that an ATM put would be expensive, and an ATM call would be cheap.

So, why not simply buy the call and short the stock? You've just created a synthetic put for "cheaper" than the real put. Then, sell the expensive ATM put and you have a conversion for a credit. Example: Let's say the ATM call is $5 and the ATM put is $10. So, you buy the call, short the stock, and sell the put. You now have made $5 on the transaction, and there's no way you can lose.

In other words, if direction was priced into options, you would be able to make money RISK FREE, which is a great idea until you discover you're 5 millionth in line for the risk free opportunity.

The reason you CANNOT price in direction is called "Put-Call parity". Here's a good link that's easy to understand:
http://www.investopedia.com/articles/optioninvestor/05/011905.asp

"market conditions are irrelevent in pricing options" is not a fair assessment. Volatility is always adjusted based upon market conditions, and that's a critical input to the Black-Scholes formula.
 
exQQQQ I hope to start discussing that soon. It is a hugely interesting subject, not to mention a critical element of the success of this methodology. I'm about worn out defending my credibility and I'm done with that. So I hope to get on with business soon. I'll start with a post I just prepared.


****************

I mentioned tax considerations before, but no one seems interested.

You know there might be one retarded guy out there who hasn’t considered the following topic, so I’m going to mention it anyway, cause even retarded people have a right to try to earn a living.

None of what follows is ADVICE, just a consideration.

January spreads are special in a lot of ways. They generally offer more strike prices than other months.
They are available (as leaps) earlier than other strike months. And most especially they offer incredible tax possibilities.

Most obviously, they allow you to initiate them early on year 1, then they complete in year 2, then you don’t pay taxes on the profit till April of year 3. That allows all the profits of year 2 to be put to work for 15 months free of taxes. Fine, obvious as hell.

Next in obviousness, is the possibility to enter spreads in early Jan of year 1, complete the position in late Jan year 2, and maybe pay only long-term tax rates in april year 3. I don’t know yet if that actually works, but it might.

Less obvious is a more complex scenario that will take some time to describe, So I recommend that any option snobs go find something else to do:

For this example we discuss a hypothetical spread ABC Jan08 50/55 that was entered into July 07 for a spread cost of $4.00. The stock was at 63. We BTO the ABC JAN08 50 call for $13. We STO the ABC JAN08 55 call for $9.
Now it’s Dec 07 and the position is as follows: The stock is at 69. The long 50 call now is worth $19.70, and the short 55 call is worth $14.9. The spread is worth 4.8 now.
So at this point in time the long call has a gain of $670 ( $1970-1300)).
The short call has a loss of $590 (900 – 1490).

Hypothetically, an unscrupulous, unpatriotic stinker could say to himself, “Well I’ve got too much short term gain this year. I’ll BTC the 55 call, and take a $590 loss this year to off set some of that gain”. The stinker reasons: “ I’ll save $200 in taxes this year.” So our unscrupulous friend then wait till Jan, sells the 50 call, collects a $670 gain that he will reinvest along with the $200 in saved taxes, so the earnings will pay off the tax burden the following year.

I think this works folks, but I’m not a professional tax advisor.
 
Fully articulate
Thank you for responding. I am aware of parity and I know that the situation I proposed is not possible because of parity. It was meant to be humorous.

What I was curious about was if a declining market expectation would somehow show up in option pricing, and if the information could be extracted somehow from a study of option prices to help predict an upcoming bear market for the stock in question.

It seems to me that declining option prices across the board would more likely be percieved as declining volatility rather than as a declining outlook for that stock.

A declining outlook for the stock would tend to increase volatility wouldn't it?

Think there is any way to distinguish between the two factors?
 
Quote from yucca_mtn:



Hypothetically, an unscrupulous, unpatriotic stinker could say to himself, “Well I’ve got too much short term gain this year. I’ll BTC the 55 call, and take a $590 loss this year to off set some of that gain”. The stinker reasons: “ I’ll save $200 in taxes this year.” So our unscrupulous friend then wait till Jan, sells the 50 call, collects a $670 gain that he will reinvest along with the $200 in saved taxes, so the earnings will pay off the tax burden the following year.

I think this works folks, but I’m not a professional tax advisor.
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I don't know... Watchout for the Constructive Sale rules. Could be wrong tho, so definitely consult a trader tax specialist. If you can find one.

Trading and taxes. What a #$%&ing nightmare!


From Pub 550
Constructive Sales of Appreciated Financial Positions
You are treated as having made a constructive sale when you enter into certain transactions involving an appreciated financial position (defined later) in stock, a partnership interest, or certain debt instruments. You must recognize gain as if the position were disposed of at its fair market value on the date of the constructive sale. This gives you a new holding period for the position that begins on the date of the constructive sale. Then, when you close the transaction, you reduce your gain (or increase your loss) by the gain recognized on the constructive sale.

Constructive sale. You are treated as having made a constructive sale of an appreciated financial position if you:
Enter into a short sale of the same or substantially identical property,

Enter into an offsetting notional principal contract relating to the same or substantially identical property,

Enter into a futures or forward contract to deliver the same or substantially identical property (including a forward contract that provides for cash settlement), or

Acquire the same or substantially identical property (if the appreciated financial position is a short sale, an offsetting notional principal contract, or a futures or forward contract).


You are also treated as having made a constructive sale of an appreciated financial position if a person related to you enters into a transaction described above with a view toward avoiding the constructive sale treatment. For this purpose, a related person is any related party described under Related Party Transactions, later in this chapter.

Exception for nonmarketable securities. A contract for sale of any stock, debt instrument, or partnership interest that is not a marketable security is not a constructive sale if it settles within 1 year of the date you enter into it.

Exception for certain closed transactions. Do not treat a transaction as a constructive sale if all of the following are true.
You closed the transaction before the end of the 30th day after the end of your tax year.

You held the appreciated financial position throughout the 60-day period beginning on the date you closed the transaction.

Your risk of loss was not reduced at any time during that 60-day period by holding certain other positions.


If a closed transaction is reestablished in a substantially similar position during the 60-day period beginning on the date the first transaction was closed, this exception still applies if the reestablished position is closed before the 30th day after the end of your tax year in which the first transaction was closed and, after that closing, (2) and (3) above are true.

This exception also applies to successive short sales of an entire appreciated financial position. For more information, see Revenue Ruling 2003-1 in Internal Revenue Bulletin 2003-3. This bulletin is available at www.irs.gov/pub/irs-irbs/irb03-03.pdf.

Appreciated financial position. This is any interest in stock, a partnership interest, or a debt instrument (including a futures or forward contract, a short sale, or an option) if disposing of the interest would result in a gain.

Exceptions. An appreciated financial position does not include the following.
Any position from which all of the appreciation is accounted for under marked to market rules, including section 1256 contracts (described later under Section 1256 Contracts Marked to Market).

Any position in a debt instrument if:

The position unconditionally entitles the holder to receive a specified principal amount,

The interest payments (or other similar amounts) with respect to the position are payable at a fixed rate or a variable rate described in Regulations section 1.860G-1(a)(3), and

The position is not convertible, either directly or indirectly, into stock of the issuer (or any related person).

Any hedge with respect to a position described in (2).


Certain trust instruments treated as stock. For the constructive sale rules, an interest in an actively traded trust is treated as stock unless substantially all of the value of the property held by the trust is debt that qualifies for the exception to the definition of an appreciated financial position (explained in (2) above).

Sale of appreciated financial position. A transaction treated as a constructive sale of an appreciated financial position is not treated as a constructive sale of any other appreciated financial position, as long as you continue to hold the original position. However, if you hold another appreciated financial position and dispose of the original position before closing the transaction that resulted in the constructive sale, you are treated as if, at the same time, you constructively sold the other appreciated financial position
 
You guys sound like a bunch of kids! I thought you were "Elite Traders". yucca_mtn is definitely not a spammer. He's posting here to share his knowledge and learn from others.
 
Quote from nuggo:

You guys sound like a bunch of kids! I thought you were "Elite Traders". yucca_mtn is definitely not a spammer. He's posting here to share his knowledge and learn from others.
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Said the guy with 2 posts.

We are all excited about trading LEAPS to save on taxes so carry on with this late night comedy show.

Can i get a copy of this free book?


daddy's boy -> no paid option course or seminar is ever worth it, there is nothing new that can be taught that isnt already available for free. Dan Sheridan recommends selling cheap gamma(<7delta verticals) to his newest students as an income generating strategy. I have no respect for people who do this.
 
Quote from rallymode:

Said the guy with 2 posts.

We are all excited about trading LEAPS to save on taxes so carry on with this late night comedy show.

Can i get a copy of this free book?


daddy's boy -> no paid option course or seminar is ever worth it, there is nothing new that can be taught that isnt already available for free. Dan Sheridan recommends selling cheap gamma(<7delta verticals) to his newest students as an income generating strategy. I have no respect for people who do this.
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That may be so, but I understand that optioncoach used to have a credit spread trading journal that has a very similar approach, i.e. selling the <7 delta vertical. The difference between his and Dan's is that Dan uses an IC instead. Seems like a reasonable income strategy for those who can't pick direction well. What strategies do you use to 'generate income'?
daddy's boy
 
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