whats wrong with this strategy?

F

frostengine

I am trying to figure out if this strategy would work, but i'm new to options...so would appreciate some criticism on this strategy.

For this example lets assume its a future option on YM, going by todays prices I get the following example:

Sell 1 naked call, strike price 11350 for 120
Proceeds=120x5=$600 dollars

Now, if price stays anywhere under, no matter how far under 11350 at experiation, I profit $600

If price goes to 11450, I buy 1 YM at 11450, so now its a covered call

If price now goes to 12000 at experiation wont matter, they just take my 1 YM at 11450, so i still make profit of $600 correct?

Continue assuming price went to 11450, so i bought the 1 ym there, making it a covered call....

If price goes from 11450 to somewhere above 11350 I loose some of my $600 but even if it goes to 11350, i at least still make $100 dollars on the deal when it gets called away....

If price drops from 11450 to below 11350 I eat a loss until the YM stops dropping... and just continue to hold the YM and maybe sell more calls on it... this is the worse case scenario....


So in summary, if the price just drops after selling the call, i make my $600, if it goes to 11450 and continues up from there I make my $600, if it goes to 11450 and then drops, I loose some of my profits... but guranted still $100... if it goes bellow 11350, i lose money on the deal and just keep the YM and play it out at a later date...

Did i assume all of this correctly or am I missing some big pieces of the pie?
 
Since you are buying the YM at 11450 and sold the call at 11350, you are already down $500 at the time you bought the YM to make the covered call. This is because above 11350, you owe someone a YM at that price.

If you bought YM at 11450 and it dropped to 11350, you would make $100. You'd be losing $500 on the YM, and the call would expire worthless so you'd retain the $600 - net $100.
 
(1) You didn't have a well-defined exit strategy, especially if the trade turned into a loser. (2) Don't "leg into" a covered-call with the futures contract. (3) Offset the call option instead. Otherwise you'll more than likely increase your loss. (4) Don't refer to the trade as being a "deal" nor talk about "playing" with a futures contract as an afterthought. That's indicative of a being a rank amateur.
 
Thanks for the help, here is Another scenario i'm looking at dealing with spreads...

Looking at DIA options right now, i see that the 111 call is 2.60 and the 112 is 1.85

So what If I think the DIA is going to go down in the next month...

So I short 1, 111 call for 2.60, so i have 260 proceeds
and i buy 1, 112 call for 1.85, so i have debit of 185..

Net is $75...

If the dia goes below 111 I make the $75 correct?
And if it expires somewhere ABOVE 111 the MOST I can loose is the difference between the two 111-112 which is 1-.75=$25..

So if i'm looking at this correctly IF I am right I make $75, if wrong most I loose is $25.... which is a pretty good risk/reward I believe...

Is their any flaw to this, or is that how it actually works out?

Thanks for your help
 
Quote from frostengine:

Thanks for the help, here is Another scenario i'm looking at dealing with spreads...

Looking at DIA options right now, i see that the 111 call is 2.60 and the 112 is 1.85

So what If I think the DIA is going to go down in the next month...

So I short 1, 111 call for 2.60, so i have 260 proceeds
and i buy 1, 112 call for 1.85, so i have debit of 185..

Net is $75...

If the dia goes below 111 I make the $75 correct?
And if it expires somewhere ABOVE 111 the MOST I can loose is the difference between the two 111-112 which is 1-.75=$25..

So if i'm looking at this correctly IF I am right I make $75, if wrong most I loose is $25.... which is a pretty good risk/reward I believe...

Is their any flaw to this, or is that how it actually works out?

Thanks for your help
More...

the one other thing you might want to consider is that you have a probability of about 30% of actually keeping the $75 so you do need to throw that into the mix...and a probability of 60% of losing the $25 in addition to the $75 you make. If you went up to 112-113 you will have a higher probability of keeping a smaller credit. I always think of the probabilities of actually keeping the credit on credit spreads and if the probability is less than 50% I usually don't enter the trade, but that is my preference...you may prefer higher risk/higher reward.
 
Delta as a proxy to CND is moot at best -- it's model based. Terminal values are usually misleading for risk assessment.
 
The flaw was that you appeared to assume that there was an equal chance, 50%, of either outcome happening. Not so. The delta of an option is it's responsiveness to price changes in its underlying contract. It can also be thought of as the likelihood of the option settling in-the-money at expiration. Options that are deep-out-of-the-money have small deltas. There's a smaller likelihood of the market trading through the strike price. At-the-money options usually have a delta of 50. There's a 50% chance of the option being in-the-money at expiration. That's a simpler way of looking at it. In your example, you need to look at the delta of each option to get an idea of the market's expectation that: (1) the market will move below 111, (2) remain between 111 and 112, (3) the market will move above 112.
 
thanks again for the help...

So you base the likelyhood of an event happening by the delta of the option....

What if however through other means, fundamentals,TA.. whatever system you have for trading the underling security, historically your system is right close to 40% of the time....

So if your system is right close to 50% of the time and it believes it will move below 111.. would you still use the delta in determining the likelyhood of that option expiring worthless?

My take on it is if the system is right 50% of the time, and your only risking at MOST $25 to make $75 then you have a good trade..

I am trying to take my experince from tracking the underlining to help make low risk trades on the options... Does the concept of using a method like that make sense or is it generally better to use the delta in determing odds?
 
Quote from frostengine:

How did you figure out the 30% chance of keeping the $75 and a 60% chance of loosing the $25?
More...

probabilities are included in the trading platform I use (TOS) and are based on a propriatory system that of course is based on the standard systems using IV's etc. I've found it to be very helpful when considering strikes in my OTM IC's on the spx.
 
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