Options as an insurance - Why is it not working? Or does it? VAR 5% How?

[morganpbrown]

It's just a generic Black-Scholes tool, it works w/o any market data.

Best would be if you post a complete example with your source of data and/or tools etc.

Take SPY as the obvious example. Mar 18 2022 400 call = $59.70, SPY price = $452.30. $52.30 of intrinsic value, $7.40 of extrinsic value. The extrinsic value is 12.4% of the option price; this is the price of your insurance.

Over 2 months, let's say SPY moves up by $20 to $472.50. The call is now $72.30 ITM. The Jan 21 2022 380 call is the proxy for your 400 call after two months. The 380 call is worth $75.60; $72.30 = intrinsic value, $3.30 = extrinsic value. So in other words, you capture the $20 upside in SPY, and lose $4.10 of the original extrinsic value. You are $4.10 behind a long stock position (though you only spent 13.1% of the cost of buying 100 shares)

Let's now say that SPY falls by $50 over two months. The 400 call is only $2.30 ITM. The Jan 21 2022 450 call is the proxy for your 400 call after two months. It is worth $14.79; $2.30 in intrinsic value, $12.49 of extrinsic value. If you were long stock, you were down $50. If you own the 400 call, you are only down $44.91.

Let's go further and model a real correction; SPY falls $100 over two months. The Jan 21 2022 500 call is the proxy for the 400 call. It is only worth 35 cents, so essentially zero. Your option position loses $59.70-$0.35 = $59.35. If you owned 100 shares of stock, you lost $100.

Obviously, my calculations assume that IV is unchanged, and that's not going to be true in practice. Honestly, IV is pretty low right now, so in the event of a downturn, it's going to rise, and it will provide a little upside "kick" to your long option.

So to summarize:
SPY + $20 => You lose $4.10 of upside relative to owning shares
SPY - $50 => You lose $5.09 less relative to owning shares
SPY - $100 => You lose $40.65 less relative to owning shares

Does this all make sense? Is this the kind of "insurance" that you were looking for from options?

 

[newwurldmn]

Take SPY as the obvious example. Mar 18 2022 400 call = $59.70, SPY price = $452.30. $52.30 of intrinsic value, $7.40 of extrinsic value. The extrinsic value is 12.4% of the option price; this is the price of your insurance.

Over 2 months, let's say SPY moves up by $20 to $472.50. The call is now $72.30 ITM. The Jan 21 2022 380 call is the proxy for your 400 call after two months. The 380 call is worth $75.60; $72.30 = intrinsic value, $3.30 = extrinsic value. So in other words, you capture the $20 upside in SPY, and lose $4.10 of the original extrinsic value. You are $4.10 behind a long stock position (though you only spent 13.1% of the cost of buying 100 shares)

Let's now say that SPY falls by $50 over two months. The 400 call is only $2.30 ITM. The Jan 21 2022 450 call is the proxy for your 400 call after two months. It is worth $14.79; $2.30 in intrinsic value, $12.49 of extrinsic value. If you were long stock, you were down $50. If you own the 400 call, you are only down $44.91.

Let's go further and model a real correction; SPY falls $100 over two months. The Jan 21 2022 500 call is the proxy for the 400 call. It is only worth 35 cents, so essentially zero. Your option position loses $59.70-$0.35 = $59.35. If you owned 100 shares of stock, you lost $100.

Obviously, my calculations assume that IV is unchanged, and that's not going to be true in practice. Honestly, IV is pretty low right now, so in the event of a downturn, it's going to rise, and it will provide a little upside "kick" to your long option.

So to summarize:
SPY + $20 => You lose $4.10 of upside relative to owning shares
SPY - $50 => You lose $5.09 less relative to owning shares
SPY - $100 => You lose $40.65 less relative to owning shares

Does this all make sense? Is this the kind of "insurance" that you were looking for from options?

that’s a lot of words. I assume this is cutting edge options math.

 

[morganpbrown]

that’s a lot of words. I assume this is cutting edge options math.

I wouldn't bother reading it if I was you. If it's coming out of my keyboard, it probably ranges between Crap and outright disinformation . Technically-correct-but-uninsightful is a stretch goal

 

[thecoder]

@morganpbrown, thx for the detailed example. But it uses a DTE of just 5 months, right? It gets costly doing this for the said whole year (cf. OP), isn't it?
Another problem is how to calculate the percentage loss: ie. if the Call expires worthless, then what is your loss in percentage? IMO it's 100% loss. But we wanted to limit the loss to 5%. How much is it according to your calculation?
But I must admit that I haven't grasped yet the role of the said proxy strike... Does it mean buying another Call?

In the initial posting of this thread a stock position had to be protected/insured, but then you offered a solution w/o the stock, by using just a Long ITM Call option. Just reminding how we got here.

 

[traider]

Can't believe! Show me... the money
Or are you just sarcastic, trying to make a bad joke or a satire, maybe?

Read the guru's thread. He already leaked many many option strategies without any losses that are always profitable from inception.

 

[morganpbrown]

But I must admit that I haven't grasped yet the role of the said proxy strike... Does it mean buying another Call?

The "proxy option" is not a profound concept; just a quick way to model an option's price as time passes and the underlying price changes. Say you own an option with 120 DTE that is $50 ITM. What will that option be worth with 90 DTE if the underlying moves up $20? You could a) model it with Black-Scholes, or b) look at an option - today - with 90 DTE that is $70 ITM. b) is the "proxy option".

 

[BlueWaterSailor]

The "proxy option" is not a profound concept; just a quick way to model an option's price as time passes and the underlying price changes. Say you own an option with 120 DTE that is $50 ITM. What will that option be worth with 90 DTE if the underlying moves up $20? You could a) model it with Black-Scholes, or b) look at an option - today - with 90 DTE that is $70 ITM. b) is the "proxy option".

I learned this a while back from a convo with a former floor trader. His boss would literally slap him on the head when he was trying to calculate the premium for up/down moves and go "duh, LOOK AT THE CHAIN." I'm told it didn't take more than a couple of smacks for him to get it...

 

[morganpbrown]

I learned this a while back from a convo with a former floor trader. His boss would literally slap him on the head when he was trying to calculate the premium for up/down moves and go "duh, LOOK AT THE CHAIN." I'm told it didn't take more than a couple of smacks for him to get it...

Well, this is my pat on the back for the day: I actually do something that real trader would consider common sense. Maybe this is going to work out...or maybe it's not!

 

[KateshiBlack]

My understanding is that an option is an insurance. So it is worthwhile to imagine options in practice to understand them.