SPX Credit Spread Trader

Quote from cdowis:

I think of POT as the "scare" factor. How likely is the maket to touch my stop out price. Most of my losses occurred because I was stopped out of a position, rather than the actual price at expiration.
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POT can be used to measure how often you will stop out. If you have a lower POT, it means you have a smaller chance of stopping out.

If you found that your loss came from stopping out, you might want to select your short strike with a lower POT.

Usually when POT increases to a uncomfortable level, I will hedge partially even it doesn't touch my short strike. Because if you have a bigger chance of getting stop out, you should close with smaller loss, or make partial hedge to compensate your potential loss.
 
The whole problem with using either POT or POE is that as soon as you put the trade on they will of course change. POE is helpful in the decision of where to open.
However I certainly haven't figured out how best to use POT (and I don't inhale:p)

And actually in equities I don't use POE that much...because usually I have a directional bias. POT is definitely just more of a point of fear..."ok I'm pretty sure it will touch therefore I need to mentally be prepared for it".

We do have an incredible number of tools to chose from...charts, oscillators, greeks (from which POE & POT are determined) and our own opinion. From this witches brew we cook up and manage a trade, each person like most chefs changing the amounts and combinations to taste.

edit...its just dawned on me. most of us are CREDIT spread traders...right? perhaps the BEST use of POT is to plan your exit on a DEBT trade...buy something with a 50/50 POE but an 80-90%POT and exit when its touched? I'll have to give that some more thought:cool:
 
Sorry if this is way out of the topic on hand.I was thinking different strategies and really like to hear your thoughts on this.

I am looking to buy some dividend paying stocks to have a balanced portfolio.I am looking at ticker symbol FRO which is 40(approximately). Its paying $6 dividend per year.


Stock price:$40
Dividend:$6
ROI:$6/$40 = 15%

If i buy the stock on margin:
Stock price:$20
Margin loan:$20
Margin interest: 7% per year. i.e $1.4

Now the ROI becomes:
Dividend - Interest i pay = $6 - $1.4 = $4.6
ROI:$4.6/$20 = 23%


If i write a deep ITM covered call at 20 strike:
Premium received:$19
ROI:$4.6/$1 = 460%?????????:eek:

So,by putting only $1000, i can buy 1000 shares and collect $4600 in dividend less commissions???????

Am i missing something here?. please be kind if i am making some dumb mistake here:(
 
heather,

if you wrote the call.....the stock would have to trade down to $20 for you to collect the premium......so in essence it is just covering the lose from your $40 starting point
 
Heather, I've done this is in the past. The problem with the deep
ITM call on dividend stocks is that they have minimal extrinsic premium. When it gets close to the ex-div date, you are at risk of having your written called exercised and the stock taken from you write before the dividend. There is a reasonable formula for determining the likelihood of early assignment:

Strike price * interest rate * days to expiry/360 - dividends

If the result of that calculation is greater than the price of the corresponding out of the money call or put, your short option is a candidate for early exercise

There is a strategy called "hedged Div capture" that does something similar to what you've discussed. It usuually uses front month options tho', so the leverage and downside protection isn't as great as you are hoping for.

Cheers,
 
Quote from Heatheranderson:


Stock price:$40

If i write a deep ITM covered call at 20 strike:
Premium received:$19...

Am i missing something here?
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Yes, you are missing something important. If the stock is 40 and you sell the 20-strike call for $19, then you are selling the call at $1 BELOW PARITY.

Any market maker who buys the 20-strike call at 19 is going to do 2 things. First he is going to sell stock (short) at $40. Then he will immediately exercise the call he bought. That locks in a profit of $100 each time he can do this.

Thus, there is ZERO chance of receiving and dividends with this strategy.

Mark
 
Mark
I intend to write LEAP Call that is deep ITM. I dont think option clearing corporation(OCC) can assign me that market makers call exercise until the leap becomes front month contract.
Meanwhile, i will be collecting the fat dividend:D




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Yes, you are missing something important. If the stock is 40 and you sell the 20-strike call for $19, then you are selling the call at $1 BELOW PARITY.

Any market maker who buys the 20-strike call at 19 is going to do 2 things. First he is going to sell stock (short) at $40. Then he will immediately exercise the call he bought. That locks in a profit of $100 each time he can do this.

Thus, there is ZERO chance of receiving and dividends with this strategy.

Mark
 
you can be assigned on any written option, no matter the month - it only requires the option buyer to exercise his "option". This would be a rational decision when the dividend exceeds the carrying costs and the premium. For large dividend stocks, the premium is relatively depressed - so even on a LEAP, this may occur (although it is certainly less common). I'm not saying that this play can't work, as it is one I have done multiple times, but the numbers are trickier than at first glance.

Remember that pretty much everyone is looking at this type of potential arbitrage play, so there is usually a reason the return looks fat.

I did this type of play with PCU when the premiums were very large. It has (so far) worked okay - but the large premium was the reward for the volatility...

Cheers
 
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