Morphing a covered call into a short strangle

Another good idea for an adjustment: sell the stock and go naked like a regular straddle. However, I'm not prepared for that risk. I can afford the stock going to zero--jumping 400% though we be a tad much, and that's possible.

But let me be clear: I'm way ahead in the money, and my original idea is in place (did start out as a covered call): Stock goes way up and I keep both premiums and let go of the stock for more than I paid. I fully intended to have the call exercised, and with the put then worthless (expires on the same day), I'll have a 50%+ return. Isn't volatility my friend as long as the stock moves to the upside?

Alternatively, Ryan's idea of continually rolling strikes to collect premium seems good, if not better, than the original plan--I'll have to see how the prices move.

As it stands, Mar 17 is looming and I may end up better than when I entered the trade.

I'll post back the result, as making public any good or bad trade is a good way to burn the experience into one's brain.

thanks for the advice.
 
Libranalysis,

I like this strategy and have made money using it for a long time if you stay small.

Assumption: you have a long term view of one year or more of the stock going higher.

The next step is to watch the extrinsic value of the strangle. When the extrinsic approaches zero on one side, its time to roll out in time.

The roll out should consider the vol skew further out. Don't be afraid to go out one year if the vol skew is flat or even rising. As pointed out, there is in all likelihood a very valid reason for the elevated vols like some binary event but model the stock going to zero and if you are happy with that risk, move forward - otherwise, you need to reduce your size....

You will get more premium if you now move to a Straddle. Pick the best expiry based on the vol skew and look at the Straddle with the largest total extrinsic value and sell that one to one with your stock. The max return will equal the strike plus total premium collected - try to get 40% or more on an annual basis.

If it rallies, they take your stock away for 40% return at expiry or you will dollar average down and simply repeat same process till stock is at zero or stock is called away. Try to pick longer dated expiry after December so tax is not owed for another year!
 
Stymie, I appreciate the detail here. Yes, this is BCRX and the IV is over 300%. The binary event is earnings Monday but more importantly expected drug results by end of March.

What I ended up with after using my newly invented random trading technique (someone accused me of having a sense of humor earlier), is an asymmetrical straddle with break evens of 3.84 and 13.67 and the price at 5.49.

I looked a modification scenarios of selling more calls or puts at different strikes, but I didn't find a risk profile I liked better than what I have. Worst case: I own a bunch of shares at a fairly low entry. I'd like to avoid that, but didn't see a way to do that without bringing my upside break even closer.

riskprofileBCRX.png
 
I don't get your strategy... you say there are 2 events (big ones) coming up in a highly volatile pharmaceutical stock....

That IV is there for a reason, 300+ for 3 week out options is a very high vol. I think that strangle is too thin... it should be wider. Looking at the options I would say a 3 dollar move is on the table.... that would take it to 2.50 - 8.50

You should be selling a strangle around these levels instead of closer to ATM.... and not a naked straddle, since that would pick up delta's when it moves away. That can go against you very quick and hard.
 
You'd have to read the thread from the beginning to understand that I first traded a covered call believing in a big move up. Then the big premiums motivated me to sell some puts at a lower strike--However, I didn't think about the scenario where the stock tanks and I end up still owning my initial purchase + an addition 2k shares due to the puts.

My initial idea was followed by a mistake so calling my trades a "strategy" might not be deserved.

So possible outcomes:

  • Stock climbs dramatically and is called away; great, I make a good return.
  • Stock hangs out in the current range until March 17 expiration: I'd sell the call premiums again and lower the basis on my stock to around 2.50.
  • Stock drops, covered calls are worthless, puts are exercised and I now own 4k shares at average cost of 3.83. I'd prefer to avoid this, but I don't see a good way to move my BE lower.
  • Buy the puts back: It's possible theta and some pops in the price might allow me to buy back these puts at a profit.
  • As Stymie suggested, keep rolling out the strikes on both ends and keep collecting premium.
Finally, I've had time to further research BCRX, and owning some shares might not be a bad thing.

Thanks for your input.
 
I had the 2nd post mate... there from the beginning...

My reason for not getting you, is that you wouldn't mind owning the shares... but then limit the upside. And last but definitely not least... it's a boom/bust stock IMO.

That reasoning of you doesn't make sense to me.... The premiums are clearly very inflated because of a 50% move coming up. Why limit your upside if you don't mind owning the stock?
And on the downside, it could drop pretty hard... I wouldn't be surprised if it has bad numbers together with a bad outcome of drug result which pushes the stock to the brink of bankruptcy...

So in that case, you would own double the shares of a shitty company... Or you're not able to own the stock of a highflyer, because of the short calls...

So the only gain to be made in a risk/return way is the stock sitting still... you packing up the premium and selling the stock (which is at a loss as well, since you bought higher).

So again, I call this strategy "fucked"...
 
JackRab,

I'm finally getting what you're saying. On other stocks I've been selling CCs and don't mind owning the stock (e.g. 5 months selling CCs on CVI with a 9% dividend). But the IV is low and the longer it sits between 22-24 the happier I'll be.

The problem is (if I comprehend what your saying), is that I brought the same mindset to a different situation where the high IV might be better leveraged with other trading strategies. So while my after-the-fact selling of the puts has me in the money, there's now a higher potential for loss with a capped upside.

Is that right?

I seem to remember looking at straddles and strangles, but the break evens were so far apart I needed binoculars to see them.

Will this 5.49 stock with an IV of 300% stay between 3.80 and 13.80 for 3 more weeks? Don't know. I'll do it different next time.
 
Correct @Libranalysis

Always know what you're trading and why (in options) there's a certain IV.... Why low? Why high?

I always gage the possible move from the (ATM) straddle... so in this case that straddle is about 50% of the underlying spot price... (if a 5.50 strike was available, that would trade around 2.75). So that's the move the options traders are calculating is going to happen.

This depends a bit on how much trading there is in the options, and I can't see any traded volume/open interest at the moment...

So I would say, between 2.50 and 8.50... Might be a bit more up, if drug results are good... way more actually... but not sure about 13.80. (mind you, I'm not an expert in this stock... I merely know my options).
 
@Libranalysis ,

I just put my money where my mouth is.... it took forever to put the trade on as the options are not liquid and the stock just trended up after the opening.

As I said on Friday, the vols tell of a binary event which happened this morning. The vols are still elevated and the skew was flat out to April so I sold the 5 Straddle in April for $1.80 and bought the stock at $5. Yes - it was much lower on the opening but there is no liquidity in those options and I was the bid on every call strike. I tried !

So the payoff looks like the following:

Stock goes nowhere - I make 36% and covers the cost of my regatta in Thailand in May.
Stock goes up - I make 36% and capped.....all my options and stock disappear at expiry. I don't go back to those damn illiquid options and suffer at the market makers enjoyment.
Stock goes down - I will effectively own twice as much stock at an average price of $4.10. My options disappear and then I look at the vol skew and decide which straddle to sell next if high vols like today. If stock goes to zero, which the study did succeed so that is remote, I lose all money put at risk with twice the position size at 4.10 and not 5.

There was a big trade this morning in the September calls at the 5 Strike which tells me that someone expects something to happen later in the year. This tells me that there is a very good chance of yet higher elevated premiums in the options and a chance to sell yet another Straddle of 100% implied vols before the next binary event?

Back to fundamentals for a second, (listened to conference call) the results were good for the study and the company beat results for the quarter. This is all good news and yet the stock tanked. I was not in the stock and so for me, this was an opportunity to put on my first trade and get long. I had researched your trade idea over the weekend so I could respond to your reply so I was prepared to invest. Thanks for the tip!

Given the collapse in vols from 300% to 100%, you made out like a bandit! Just remember to cover your extra short calls as these bio stocks can jump huge and you don't want to lose on both sides of your trade idea if things move too much.

Let me know if you find any other interesting trades.
 
Greetings,

Despite my lack of experience, the trades have been profitable. I closed out my strangle and some of my other positions at a 75% return on risk. I've rolled up and/or forward some covered calls, so those now expire 4/21. This thread made me aware of synthetic positions, so after some reading, I entered a zero cost long synthetic @7 (we're now approaching 9).

I've thought about closing all and taking my profit, but the recent bird flu developments may put some upward pressure on this stock.

Finally, I have one position that expires Friday and I haven't thought of a way to squeeze more juice out of it. Perhaps you have an idea: Early March I bought 1000 stock @ 5.60 and sold 6 covered calls @1.33 expiring 3/17.

I've looked at rolling forward and/or up but nothing much seems appealing since it would turn a winning trade into maybe a better trade. Are there other clever ways to make this more profitable?

Thanks for the help.
 
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