No sir, I mean yes you would hold the shares, but you would hedge your position buying puts against say 80% of your position to minimize risk. You would collect the difference between the dividend payments you receive and the cost of the hedge. No covered calls, to me that's not the best way to go. This way you could have potential capital appreciation to the upside if the stock caught bid.
Safer option strategies
- Thread starter madbrain
- Start date
No sir, I mean yes you would hold the shares, but you would hedge your position buying puts against say 80% of your position to minimize risk. You would collect the difference between the dividend payments you receive and the cost of the hedge. No covered calls, to me that's not the best way to go. This way you could have potential capital appreciation to the upside if the stock caught bid.
cyoungmark,
Thanks for clarifying. How would you choose which protective puts to buy ? 1 yr or 2 yr LEAPS ?
Is it better to buy 80% of the puts with a strike near the purchase price, or buy 100% of the puts at a strike of 80% of purchase price ?
The later costs a lot less
T is currently around $30 with a 5.8% yield which is about $1.75/share a year in dividend, if it does not get lowered/cut.
Jan 2013 $30 put is $4.25, Jan 2014 $30 put is $6.10
Jan 2013 $25 put is $2.01, Jan 2014 $25 put is $3.30
The only scenario where the math seems to work out is buy the Jan 2014 $25 put. Cost would be $3.30 . And expected dividend would be $3.50 . 20 cents/share over 2 years if shares stay around $30 which is 0.3% per year.
Possibly more if T goes higher. 20% downside if it's $25 or below.
That insurance seems awfully expensive ...
Thanks for clarifying. How would you choose which protective puts to buy ? 1 yr or 2 yr LEAPS ?
Is it better to buy 80% of the puts with a strike near the purchase price, or buy 100% of the puts at a strike of 80% of purchase price ?
The later costs a lot less
T is currently around $30 with a 5.8% yield which is about $1.75/share a year in dividend, if it does not get lowered/cut.
Jan 2013 $30 put is $4.25, Jan 2014 $30 put is $6.10
Jan 2013 $25 put is $2.01, Jan 2014 $25 put is $3.30
The only scenario where the math seems to work out is buy the Jan 2014 $25 put. Cost would be $3.30 . And expected dividend would be $3.50 . 20 cents/share over 2 years if shares stay around $30 which is 0.3% per year.
Possibly more if T goes higher. 20% downside if it's $25 or below.
That insurance seems awfully expensive ...
That's not bad, I probably would use the former rate. I wouldn't have >30 contracts and likely the max rate would be $13 with 30, then.
Yeah, I looked at IB's commission page. 0.25 is pretty good for the cheap contracts. But 0.75 is on the higher side of things. Commission would be $22.50 with 30. Free assignment/exercise is very nice, though. I have to check what it would cost at optionshouse. I'm more concerned about assignment.
I will have to start adding commissions to my spreadsheet and see the costs.
I was specifically talking about short-term calls and puts, ie. weekly, so dividend does not come into play unless there is one scheduled that week.
For SPY it's quarterly. For example, the SPY $125 put for this friday closed at $1.27 . But the SPY $125 call closed at $2.04 . Quite a difference. Maybe the market just expects it to go up, even though today was a down day.
If I look at the LEAPS SPY puts and calls, the pattern gets inverted.
Jan 2014 $125 call is $17.32 . But Jan 2014 $125 put is $21.60 - much more.
Right, it reduces risk, and also probably eliminates the return in the process, or pushes it negative ;-)
Yes, that sounds interesting, but one would have to be fairly lucky to see the market go up during the first few weeks with the writes, and then down just before the long put expires. Things can move the other way around, too.
If I buy a 1-2 month put, there are only 4-8 weeks left to make the premium back with weekly put writes.
Profit is much more likely if one doesn't buy a long put. But risk of a sudden major market slump is there. One way to protect against it is to write a way OOM put. For example writing a put at 90 cents on the dollar on SPY almost never gets assigned. I think only once over the last 4 years, in October 2008. And the shares go back above strike within the next week.
Downside is that the premium from such OOM puts is very low. Many weeks I calculated it to be actually 0 for previous weeks of low volatility. My spreadsheet rounds down all the puts I write to the lowest cent to try to account for bid/ask spreads.
I think writing the 90% OOM puts weekly earned <1% annualized. But risk was close to 0.
Quote from madbrain:
cyoungmark,
Thanks for clarifying. How would you choose which protective puts to buy ? 1 yr or 2 yr LEAPS ?
Is it better to buy 80% of the puts with a strike near the purchase price, or buy 100% of the puts at a strike of 80% of purchase price ?
The later costs a lot less
T is currently around $30 with a 5.8% yield which is about $1.75/share a year in dividend, if it does not get lowered/cut.
Jan 2013 $30 put is $4.25, Jan 2014 $30 put is $6.10
Jan 2013 $25 put is $2.01, Jan 2014 $25 put is $3.30
The only scenario where the math seems to work out is buy the Jan 2014 $25 put. Cost would be $3.30 . And expected dividend would be $3.50 . 20 cents/share over 2 years if shares stay around $30 which is 0.3% per year.
Possibly more if T goes higher. 20% downside if it's $25 or below.
That insurance seems awfully expensive ...
That is something you would have to test and work out yourself. Just a little number crunching would be needed. I would buy 100% of puts at like 80ish percent of purchase, just because I can deal with a little risk. Plus the reason for buying the puts is to prevent something catastrophic, because if your going to be doing this, your going to do it for the long haul/yearly income so the stock would come back around usually if you wait it out. I'd purchase puts at a price that you could handle taking a loss at if you decide to take a haircut. I was looking at closer expiration of puts when I first did the math, so Maybe this strategy isn't as fool proof as it sounds.
Options are also priced based on volatility, maybe a different stock with less volatility or volume is needed.
madbrain,
In your calculations, you have some errors that you are not accounting for and they are presenting a disjointed picture:
1) Effect of dividends on put premium
2) Carry cost
3) Intrinsic value when comparing puts and calls
I'll elaborate later/tomorrow when time permits. In the meantime, see if you can spot them
In your calculations, you have some errors that you are not accounting for and they are presenting a disjointed picture:
1) Effect of dividends on put premium
2) Carry cost
3) Intrinsic value when comparing puts and calls
I'll elaborate later/tomorrow when time permits. In the meantime, see if you can spot them
If you are selling the weeklies, you also need to be careful when hedging with longer term options that are near the money due to the fact that the weekly options are much more sensitive to gamma than the LEAPS. It's not fun to be right in your direction and find the short options rocket up and put your position in to the red.
spindr0,
Thanks for downloading my spreadsheet ! (the only other download was myself, to make sure it worked
).
Hmm. I use the annual dividend rate for SPY as one of the inputs to the PUTOPTION function... Is the error that I shouldn't use it for the weekly options ? Or should I only use it for the weeks that the dividend is paid, and set it to zero for all the other weeks ?
Not completely sure what you mean by that. You mean the cost of holding the task after assignment. If you mean margin interest, this would be all in cash account so it wouldn't apply.
If I set "size of weekly bet" to >100%, margin could be used, and then I would have to calculate margin interest. But this would cause the account to blow up a couple times. Even when using margin as low as 125%, with a 50% equity requirement, there would be several dates in 2008-2009 where the equity would go below 50%. I am not very keen on ever getting a margin call.
True. I am only using the output of the PUTOPTION / CALLOPTION functions. The strategy is to write out-of-the-money puts, so they have zero intrinsic value by definition at the time they are written. One can set the target price >100% underlying too . Then this would create some intrinsic value. But it also would be extremely risky.
The puts are held to expiration, at which point both the intrinsic and market value is usually 0.
Not immediately, but thanks for the pointers.
Thanks for downloading my spreadsheet ! (the only other download was myself, to make sure it worked
).Hmm. I use the annual dividend rate for SPY as one of the inputs to the PUTOPTION function... Is the error that I shouldn't use it for the weekly options ? Or should I only use it for the weeks that the dividend is paid, and set it to zero for all the other weeks ?
Not completely sure what you mean by that. You mean the cost of holding the task after assignment. If you mean margin interest, this would be all in cash account so it wouldn't apply.
If I set "size of weekly bet" to >100%, margin could be used, and then I would have to calculate margin interest. But this would cause the account to blow up a couple times. Even when using margin as low as 125%, with a 50% equity requirement, there would be several dates in 2008-2009 where the equity would go below 50%. I am not very keen on ever getting a margin call.
True. I am only using the output of the PUTOPTION / CALLOPTION functions. The strategy is to write out-of-the-money puts, so they have zero intrinsic value by definition at the time they are written. One can set the target price >100% underlying too . Then this would create some intrinsic value. But it also would be extremely risky.
The puts are held to expiration, at which point both the intrinsic and market value is usually 0.
I'll elaborate later/tomorrow when time permits. In the meantime, see if you can spot them
Not immediately, but thanks for the pointers.
I'd be careful, selling naked front month vol is rarely most conservative or limited risk.
-2c.
Thegoonior,
I know. One fix for that is to not watch the markets at all, and just patiently wait until the put expires. Past data clearly shows that most of the time, the position reverts to positive and the put expires worthless. Trying to buy it back when it moves in the wrong direction is not helpful at all. It is a sure way to lose. For example, look at October 6 and 7, 2008 and tell me what you would have done if you wrote a put Monday morning. I can't formulate a recovery rule that works for that week, and doesn't lose money every other week.
Even trying to buy it back when it is in the money, and say, capture 80% of the gain, ends up losing you money. You have to buy it back at 95 cents on the dollar to be able to avoid a 2008 type of event. If you do that, all the trades will be profitable, but that profit is too small to both with.
If the short-term direction is wrong, the SPY shares get assigned at the end of the week, and then I can usually resell them with a few weeks for at least strike.
The problem is for those few rare times where the downturns are more prolonged, such as 2008/2009, and the shares keep going down. I don't see a clear systematic way to recover from that after assignment.
One strategy I mentioned was to resell shares at 1% loss. This would have worked for 2008. Not sure how often it would work in the future. The short-term loss on shares is almost fully made up by all the new put premiums that get pocketed as a result of freeing up the cash. It is certainly much less of a roller-coaster ride.
Otherwise, if one is not willing to take any loss on the shares, one is left holding the bag for a while. Take a look at the spreadsheet.
I know. One fix for that is to not watch the markets at all, and just patiently wait until the put expires. Past data clearly shows that most of the time, the position reverts to positive and the put expires worthless. Trying to buy it back when it moves in the wrong direction is not helpful at all. It is a sure way to lose. For example, look at October 6 and 7, 2008 and tell me what you would have done if you wrote a put Monday morning. I can't formulate a recovery rule that works for that week, and doesn't lose money every other week.
Even trying to buy it back when it is in the money, and say, capture 80% of the gain, ends up losing you money. You have to buy it back at 95 cents on the dollar to be able to avoid a 2008 type of event. If you do that, all the trades will be profitable, but that profit is too small to both with.
If the short-term direction is wrong, the SPY shares get assigned at the end of the week, and then I can usually resell them with a few weeks for at least strike.
The problem is for those few rare times where the downturns are more prolonged, such as 2008/2009, and the shares keep going down. I don't see a clear systematic way to recover from that after assignment.
One strategy I mentioned was to resell shares at 1% loss. This would have worked for 2008. Not sure how often it would work in the future. The short-term loss on shares is almost fully made up by all the new put premiums that get pocketed as a result of freeing up the cash. It is certainly much less of a roller-coaster ride.
Otherwise, if one is not willing to take any loss on the shares, one is left holding the bag for a while. Take a look at the spreadsheet.
Quote from madbrain:
How would you choose which protective puts to buy ? 1 yr or 2 yr LEAPS ?
Outlook for the underlying. Cost per day of protection (usually cheaper for longer term options).
Is it better to buy 80% of the puts with a strike near the purchase price, or buy 100% of the puts at a strike of 80% of purchase price ? The later costs a lot less
Depends on what the underlying does.
ATM insurance protects more, costs more. OTM cheaper but protects less. It's like the deductible on your health insurance. Higher premium policy is a waste of money if you have no claims but very helpful if you get hit by a Mack truck
Three ways to determine which is better. For ease of discussion, assume T is at 30, you have 500 shares and you're looking at the either 4 ATM 30 strike protective puts (PPs) vs 5 OTM 25 strike PPs (80% vs 100%).
1) Intuitive reasoning. Upside is easy. If T rockets upward, cheapest protection is best since all protection is lost money (at exp.). That's the 25's
Downside is more complex since the strikes and # of puts is different. OTM 25 strike loses equity value from 30 down to 25 where 100% PP kicks in.
ATM 30 costs a lot more and kicks in immediately but since only 80% protected, you lose 1 equity pt per pt drop. In a catastrophic drop, it's most likely to overcome the other's loss at some much lower price.
2) Compare two risk graphs. Easy to do but a bit annoying since you have to do it visually for multiple UL prices.
3) Look at a risk graph of your 4 long lower strike price puts versus 5 short ATMs. While it may seem counter intuitive, that graph will depict exactly how the hedge will perform.
As mentioned above, above 30, cheaper protection (25's) loses less. Because the 25 PP is losing 4 more pts per UL pt of drop, somewhere below the upper strike, the 30 strike PP begins to outperform.
As mentioned above, the 4/5 protection of the 30 eventually catches. I think it would be in the low teens but that's just a guess.
Awful lot of words to explain what a risk graph would depict in a quick glance. Maybe even a 1,000
T is currently around $30 with a 5.8% yield which is about $1.75/share a year in dividend, if it does not get lowered/cut.
Jan 2013 $30 put is $4.25, Jan 2014 $30 put is $6.10
Jan 2013 $25 put is $2.01, Jan 2014 $25 put is $3.30
The only scenario where the math seems to work out is buy the Jan 2014 $25 put. Cost would be $3.30 . And expected dividend would be $3.50 . 20 cents/share over 2 years if shares stay around $30 which is 0.3% per year. Possibly more if T goes higher. 20% downside if it's $25 or below. That insurance seems awfully expensive .
The reason that the put looks expensive is that with a $1.75 ann div, T is going to drop 43 cts numerous times before expiration. 5 times before '13 exp and 9 times before '14 expiration. Add in 1% per yr for carry cost and the premiuums for same strike P's and C's equalize.