Short-selling DITM options

[marsman]

Sure pal, you have it all together. Here are 3 phrases you should get used to :...assignment, margin call, blow up. And no, holding to expiry doesn't prevent any of them. I'm out !

If it goes ITM, then you hedge with the underlying. Net effect is about PnL=0. So what?
I bind the cash needed for hedging only a few days, as these are weeklys or bi-weeklys.
And when hedging activates then the position counts as "covered"...

 

[Lee-]

If it goes ITM, then you hedge with the underlying. Net effect is about PnL=0. So what?
I bind the cash needed for hedging only a few days, as these are weeklys or bi-weeklys.
And when hedging activates then the position counts as "covered"...

I understand what you're saying, you buy the underlying if the price gets close to the strike price, which will eliminate the possibility of a "blow up", remove assignment risk, and eliminate a margin call -- provided you have enough in your account to actually buy the underlying. There's 2 key problems I see with buying the underlying when the price nears the strike:

1) You actually have to have the capital in your account to buy the underlying. This means that you must limit the number of contracts you short sell such that you can afford to buy the underlying if its price comes close to the strike (this means you need to calculate based on the assumption that the underlying's price is close to the strike, not its current price, which is much below the strikes you're shorting).

2a) The case of the underlying coming near your strike and then dropping. The options trades you've been talking about are for premiums on the order of $0.2/share. If you buy the underlying when it reaches the strike, that's fine if the price continues to go up, but what if it doesn't? You lose if the price drops below your purchase price - the options premium - commissions.

2b) You could say if the underlying reaches the strike and then drops, you'll sell, but what if it begins oscillating at or near the strike. How do you deal with this situation?

I do think that buying the underlying if it gets near your strike is a way to reduce some risks, it introduces another. It also requires you to limit the how much of your account is used on a single short option position such that you can afford the underlying. This will affect your projected PnL.

Just some things to consider. I'm no expert, but I've been doing a lot of my own analysis of options planning on automating my own ideas and I'm pretty sure I know your strategy. It's pretty simple. When you have a simple strategy you need to think, "why aren't other people doing this?" The answer is almost always because the probability of loss * value of loss > probability of success * value of success, or using better statistical terms, the expected value over a long time frame is <= ~0.

 

[donnap]

If it goes ITM, then you hedge with the underlying.

Successful trading may be a long and arduous road.

You may go down this road and find that it works four out of five times. But the one that doesn't work wipes out the others.

And you may find that there is no edge to this strategy. And you may get discouraged and quit.

But you may find yourself going down many other trading roads and asking yourself, "how do I work this?"

And you may find yourself trading pairs.

And you may find yourself trading earnings.

And you may find yourself trading complex option positions.

And you may say to yourself, "My God, what have I done?"

Letting the days go by, let the water hold me down
Letting the days go by, water flowing underground
Into the blue again after the money's gone
Once in a lifetime, water flowing underground

Same as it ever was
Same as it ever was

 

[oldnemesis]

It was six men of Indostan
To learning much inclined,
Who went to see the Elephant
(Though all of them were blind),
That each by observation
Might satisfy his mind

The First approached the Elephant,
And happening to fall
Against his broad and sturdy side,
At once began to bawl:
“God bless me! but the Elephant is very like a wall!”

The Second, feeling of the tusk,
Cried, “Ho! what have we here
So very round and smooth and sharp?
To me ’tis mighty clear
This wonder of an Elephant
Is very like a spear!”

The Third approached the animal,
And happening to take
The squirming trunk within his hands,
Thus boldly up and spake:
“I see,” quoth he, “the Elephant
Is very like a snake!

The Fourth reached out an eager hand,
And felt about the knee.
“What most this wondrous beast is like
Is mighty plain,” quoth he;
” ‘Tis clear enough the Elephant Is very like a tree!”

The Fifth, who chanced to touch the ear,
Said: “E’en the blindest man
Can tell what this resembles most;
Deny the fact who can
This marvel of an Elephant
Is very like a fan!”


So oft in theologic wars,
The disputants, I ween,
Rail on in utter ignorance
Of what each other mean,
And prate about an Elephant
Not one of them has seen!

 

[der_kommissar]

Not to state the obvious, but this sounds eerily similar to the thread with the guy selling his options trading system for a few hundred k...all of it built on alot of hypothetical assumptions that don't mesh with the realities of the markets.

 

[marsman]

Not to state the obvious, but this sounds eerily similar to the thread with the guy selling his options trading system for a few hundred k...all of it built on alot of hypothetical assumptions that don't mesh with the realities of the markets.

FYI: I'm not selling anything.
Except short-selling options of course...

 

[sss12]

FYI: I'm not selling anything.
Except short-selling options of course...

. I believe der k.'s point is that this forum has seen many posters with hypo's, theories , etc. but no real world trading experience to back them up. Until there is skin in the game it is all talk.

 

[marsman]

. I believe der k.'s point is that this forum has seen many posters with hypo's, theories , etc. but no real world trading experience to back them up. Until there is skin in the game it is all talk.

Hmm, yes, I must admit this applies also to me, a newbie, as I'm still preparing for going live soon . My trades so far have all just been some test-trades, nothing real yet...
I might have some good theoretical background, but I lack practical experience yet, but hopefully this is going to change very soon.

 

[JackRab]

Hmm, yes, I must admit this applies also to me, a newbie, as I'm still preparing for going live soon . My trades so far have all just been some test-trades, nothing real yet...
I might have some good theoretical background, but I lack practical experience yet, but hopefully this is going to change very soon.

To be honest, you lack some serious theoretical background as well...

As I pointed out in your other thread... when you have an open short option it can (and will at one point) go against you in multiple scenario's, as sss12 mentioned as well.

Vola shift, a move in underlying against you, even interest rate move, dividend announcement not priced in... if that happens you WILL take a hit on your margin requirement and have to post more margin. And since you are looking to maximize your positions, probably max out your margins... you will get hit with a margin call and HAVE to cut your trade... that's really a non discussion. You can't backtrack in time and hedge your trade in hindsight..
You hit the strike, you have a theoretical/paper loss.. and have to post more margin... it's that simple.

Even if the move is not as big as to hit your strike, you can still be forced out because you have no more cash left to post the margin for the loss you have... You can't just say: "ow shit, but it's still only on paper!! So please don't ask for more margin mr Broker..."

 

[JackRab]

I hope you don't take offence at my comments Marsman, I'm only trying to make you realize some of your misconceptions about risk, so you don't get hammered...