Thanks so much, Kenneth. In fact, I don't believe we truly are on opposite sides of the discussion; I believe, rather, that our methodology or understanding or practice may differ. My position (opinion) remains as it was all along: that OTM bull call strategies are the opposite of ITM bull put strategies, both from the point of view of debit vs. credit, and the deltas being positive vs negative, respectively. Now, to address some participants' assertion that they are "the same," because they complement each other (call delta 0.01 vs. put delta -0.99=1) is not what my argument is all about. My position has been all along that in an OTM bull call spread with a tiny delta, the underlying stock would have to make an enormous move to the upside for that delta to respond, and for the spread to increase in price, and therefore be favorable to the buyer; while a similar enormous move to the upside on the ITM put spread would substantially decrease the cost of the put spread in favor of the seller, because of the delta near -1, that implies an almost 1:1 move of the options in relation to a move in the stock. Both positions are bullish. The call spread costs very little to enter, true, but would require too high a move to be influenced positively; while the opposite is true for the put.
Whether my understanding of deltas (and thetas, in this case because of the very short expiry) is supported by the other participants in this debate is irrelevant. This has been a hypothetical position all along, as I repeat, I would never select a front-month expiry for such positions, and I almost never, ever buy OTM calls. My own methodology, if I wish to buy calls, especially OTM calls, would be to go very far off into the future to allow them time to fulfill their promise. I'm generous that way. As stated previously, my own preference in regards to puts is to do OTM naked puts or bull put spreads, but OTM (at a price less than the current stock price).
My hypothetical positions on AAPL, the subject of this debate, have been placed as a virtual trade on a great new platform that is currently a private beta, going public in the near future (preferred browsers include Chrome/Safari/Firefox). To see my two spreads dance to the music in real time, please click on http://www.tradeclique.com/trader/yaelt#yael.
Another reminder of my preferences is that I generally do not wait for expiration. I got burned badly in the 1999-2000 dot.com. Whether it costs more or less in commissions is irrelevant to my peace of mind. In the hypothetical ITM bull put spread above, since it was placed with a view that AAPL would make a substantial move to the upside by the Sep. 12 unveiling of a new iPhone, my preference would be to close down my put spread as soon as it presented a "significant" profit. I put that in quotations because I cannot tell you what I would consider significant, as to time to expiry is so short. However, again, hypothetically, since I received a credit of $1800 for this trade, I might consider buying it back to close at, say, $1200 or so, being quite delighted with a profit of $600 in a few days' time (we placed this hypothetical trade around the beginning of Sep.).
Showing posts with label Put Spreads. Show all posts
Showing posts with label Put Spreads. Show all posts
Thursday, September 6, 2012
Thursday, August 30, 2012
Delta, the positive and negative
I came across a misconception about the deltas for puts and calls. Someone put forth that a Sept. expiry Bull Call Spread on AAPL was the same as a Sept. expiry Bull Put Spread with similar strike prices. In fact, the two strategies are diametric opposites. That is because calls and puts do NOT have the same deltas, even when accounting for the fact that put deltas are represented by a negative number. So, the AAPL Sept. 710 call has a delta of .0159 and the Sept. 730 call has a delta of .0000. Since a Bull Call Spread is a debit spread, the cost for this spread is tiny, $.10 x .02=$.08 per contract, or $8. The same strikes for the AAPL Sept. puts are 710 delta of -.9786 and the 730 put delta is -.9942. Since a Bull Put Spread is a credit spread, the credit received would be $18.50 on a $20 spread, i.e., $1850 credit for every $2000 margin (but the "real" or effective margin is only $150=2000-1850).
But, and this is a HUGE but -- with September expiry, you are giving no time at all for the stock to move. Sept. expiry has an enormous theta influence (meaning time erosion). If you buy the Bull Call Spread, it would cost you nearly nothing ($0.08 or $8 per contract), but the likelihood of that spread rising are almost nil, zero, zilch. You know why? Because the delta is 0. The delta determines how much the option will move for every $1 move in the underlying stock. With a delta of 0 and only 3 weeks to expiry, you would need a miracle for your $8 to go anywhere. Of course, $8 is not a lot of money, so you may want to play with it. But that would represent the true analogy to a lottery.
As for the Bull Put Spread, even though the credit is enormous, the Sept. expiry still poses a problem because of its short nature. Yes, the deltas are huge (and are represented with a negative sign), which imply just about a 1:1 move of the options for every $1 move in the stock, but again, you are giving a very short time for the stock to do anything. Very risky.
I am in the process of writing a book on this. Stay tuned, if you're at all interested
But, and this is a HUGE but -- with September expiry, you are giving no time at all for the stock to move. Sept. expiry has an enormous theta influence (meaning time erosion). If you buy the Bull Call Spread, it would cost you nearly nothing ($0.08 or $8 per contract), but the likelihood of that spread rising are almost nil, zero, zilch. You know why? Because the delta is 0. The delta determines how much the option will move for every $1 move in the underlying stock. With a delta of 0 and only 3 weeks to expiry, you would need a miracle for your $8 to go anywhere. Of course, $8 is not a lot of money, so you may want to play with it. But that would represent the true analogy to a lottery.
As for the Bull Put Spread, even though the credit is enormous, the Sept. expiry still poses a problem because of its short nature. Yes, the deltas are huge (and are represented with a negative sign), which imply just about a 1:1 move of the options for every $1 move in the stock, but again, you are giving a very short time for the stock to do anything. Very risky.
I am in the process of writing a book on this. Stay tuned, if you're at all interested
Tuesday, August 28, 2012
Deep In The Money Bull Put Spreads
Someone compared a Deep ITM Bull Put Spread strategy to a lottery. Indeed, it is anything but. Rather, it is a very sound, safe strategy. Consider that Bull Put Spreads are credit spreads, and the deeper ITM you go, the bigger the credit (i.e., money in your pocket). Also, the farther out you go in time to expiry, the greater the chance that the stock will make a big move. For example, let's take AAPL. At its current market price, $676 or so, a Deep ITM Bull Put Spread might be something like a 2014 expiry 770/780 Bull Put Spread, which will fetch approximately $700 per margin of $1000 per contract ($770-$780=$10 x100 per contract=$1000), or 70% return, with a risk of 30%. How do I figure the risk? Simple: You receive $700 credit for each contract, and while the margin requirement is $1000 per contract, the $700 mitigates against that, thus reducing your out of pocket, and putting you at risk for only $300 IF the stock does not make the expected move, and IF you choose to keep it open until expiry. In this case, you are about $100 ITM (AAPL $676; strike price $780), but your risk is only 30% if AAPL fails to reach $780 by Jan. 2014. Moreover, you are not obliged to hold on to this spread until expiry. If AAPL comes out with new products or wins another legal case, or declares a split, or whatever, it could surge, thereby lowering the spread amount, in which case you can buy it back to close. Even if AAPL does not surge, but simply meanders slowly through the months, at $780, you are assuming a $104 rise in the stock price, which represents a 15.3% rise in 18 months, certainly within the realm of possibility for this stock. Again, the credit (money in your pocket) is 70% on a risk of 30%. In my book, that is not a lottery ticket at all, but a very sound strategy.
A Bull Put Spread is a strategy where the underlying stock can stay the same (you profit by the erosion of time), rise (you profit by the decrease in the puts) and even decline a little (by the amount of the credit received).
Is there a risk to this strategy? Yes, and here it is: If AAPL falls precipitously in price, the Bull Put Spread INCREASES in value. Thus, it may trigger a margin call, unless you are very well funded. The operative word here is may. There are many situations where the market takes a tumble, even a severe correction, yet nothing happens to your long-term positions. On the other hand, you may be called upon to reduce your margin, in which case, you simply buy the spread to close.
Remember: A PUT increases in value as the underlying stock price decreases. A CALL increases in value as the underlying stock price increasees.
A Bull Put Spread is a strategy where the underlying stock can stay the same (you profit by the erosion of time), rise (you profit by the decrease in the puts) and even decline a little (by the amount of the credit received).
Is there a risk to this strategy? Yes, and here it is: If AAPL falls precipitously in price, the Bull Put Spread INCREASES in value. Thus, it may trigger a margin call, unless you are very well funded. The operative word here is may. There are many situations where the market takes a tumble, even a severe correction, yet nothing happens to your long-term positions. On the other hand, you may be called upon to reduce your margin, in which case, you simply buy the spread to close.
Remember: A PUT increases in value as the underlying stock price decreases. A CALL increases in value as the underlying stock price increasees.
Tuesday, August 21, 2012
Suggestive Lexicon - Even More Interesting Tactics
I'm talking here about being naked and legging in and out. Don't get carried away - I didn't make these up, I swear!
I love to sell naked puts. That is, in fact, my favorite strategy. But I also love Bull Put Spreads. Let's see what I did with AAPL.
When AAPL was trading around $500, I sold to open (STO, in the jargon) a 2014 LEAP put at a strike of $450. When AAPL rallied after earnings, I bought back that put to close (BTC) for a profit, and rolled out to 2014 $500 strike. When AAPL again rallied, I "covered" this naked put with a long put by creating a Bull Put Spread - I bought to open (BTO) a 2014 $450 put. In time, AAPL has continued to defy gravity, rising ever more, and I have been keeping a keen eye on my short puts. With the imminent launch of the iPad 5 in September 2012, my $500 expiring in 2014 put had before very profitable. I therefore placed a trailing stop of $2 to buy it back to close, in order to secure my profits. I kept my long $450 put intact, in case the stock rallies, and then takes a tumble as other traders also take profits. In that event, my long put would increase in value.
Here is what I love about Bull Put Spreads: As the name implies, you put those on with a bullish expectation on the underlying stock. But with Bull Put Spreads, you needn't be all that bullish - just bullish enough. One of the benefits of doing Bull Put Spreads is that you are getting money into your account immediately, because these spreads are credit spreads. Another benefit is that, if the underlying stock tumbles significantly, your long put becomes profitable, and when that happens, I like to sell it for a profit, thus "legging out" of the spread. I took a credit to begin with; I'm now selling the long put at a profit, thereby taking in more money; and I'm leaving the naked put in place with the expectation that the stock will recover. Such was the case with CMG. It had gone from about $340 down to $285, and then stabilized. At that point, I wrote a Bull Put Spread expecting the stock to find its legs again.
I love to sell naked puts. That is, in fact, my favorite strategy. But I also love Bull Put Spreads. Let's see what I did with AAPL.
When AAPL was trading around $500, I sold to open (STO, in the jargon) a 2014 LEAP put at a strike of $450. When AAPL rallied after earnings, I bought back that put to close (BTC) for a profit, and rolled out to 2014 $500 strike. When AAPL again rallied, I "covered" this naked put with a long put by creating a Bull Put Spread - I bought to open (BTO) a 2014 $450 put. In time, AAPL has continued to defy gravity, rising ever more, and I have been keeping a keen eye on my short puts. With the imminent launch of the iPad 5 in September 2012, my $500 expiring in 2014 put had before very profitable. I therefore placed a trailing stop of $2 to buy it back to close, in order to secure my profits. I kept my long $450 put intact, in case the stock rallies, and then takes a tumble as other traders also take profits. In that event, my long put would increase in value.
Here is what I love about Bull Put Spreads: As the name implies, you put those on with a bullish expectation on the underlying stock. But with Bull Put Spreads, you needn't be all that bullish - just bullish enough. One of the benefits of doing Bull Put Spreads is that you are getting money into your account immediately, because these spreads are credit spreads. Another benefit is that, if the underlying stock tumbles significantly, your long put becomes profitable, and when that happens, I like to sell it for a profit, thus "legging out" of the spread. I took a credit to begin with; I'm now selling the long put at a profit, thereby taking in more money; and I'm leaving the naked put in place with the expectation that the stock will recover. Such was the case with CMG. It had gone from about $340 down to $285, and then stabilized. At that point, I wrote a Bull Put Spread expecting the stock to find its legs again.
Tuesday, April 26, 2011
Adjusting the Legs
Recall that I had two spreads on the stock: May 2011 $260-$265 Bull Call Spread and the May 2011 $235-$240 Bull Put Spread. Both spreads are bullish; both spreads were set to expire May 2011.
With the stock currently down about $16.75, the call options are trading lower (the call options are currently out of the money - OTM), while the put options are trading higher (the put options are currently in the money - ITM), I have executed a few adjustments, as follows:
I bought to close (BTC) the May 2011 $265 call options for $2.90 ($290 per contract). I sold them yesterday at $9.75 ($975 per contract), so my profit on this leg is $6.85 ($685 per contract). That leaves a Long Call at the $260 strike expiring May 2011. This is a Long Call (Long means that I own this position), therefore, there is no Margin Requirement.
I sold to close (STC) the May 2011 $235 put options for $10.35 ($1,035 per contract). I bought them yesterday at $8.25 (of $825 per contract), so my profit on this leg is $2.10 ($210 per contract). That leaves a Naked Put at the $240 strike expiring May 2011. This is a naked position, therefore, there is a Margin Requirement of $5,977. 00.
Why did I adjust these legs? From past experience, it seems that there is a knee-jerk reaction to negative news, and I am betting that the selling action is overdone, and the stock will recover. So far, by removing those two legs (the short call* and the long put*), I have put $895 back into my account. I opened both spreads yesterday at almost no cost to me. My risk here is that the stock will not recover to the $240 strike naked put, in which case the stock will be put to me, and I will be obligated to buy it at the strike of $240 (refer to the lexicon for definitions). As expiration approaches, I can reevaluate my position to see if the fundamentals of the stock are still interesting enough to wish to hold the stock, and if not, I can simply buy back to close that naked put, thereby relieving myself of that obligation. In the event I do wish to allow the stock to be put to me, my break-even cost would be $240 (the strike price) less the profit of $895 I just realized, or $231.05. Looking out to some long-term call options, selling a covered call would bring down the price even more.
With the stock currently trading at around $236, the $240 strike naked put is trading at around $12, which is $4 in the money (ITM) - $240-$236 - and a full $8 out of the money (OTM), or time value. With May expiration being just 3 weeks away, the Theta of the option erodes extremely fast. The Theta refers to how much value an option price will lose with every day that passes. The closer to expiration, the faster an option loses value.
On May 11, 2011, the market started to jiggle (to the downside) a bit more than I like. NFLX was trading up to $241, but then regressed down to $238, so I decided to roll out my naked puts to June 2011. By rolling out, I closed (BTC) my May 2011 open position $240 Naked Put at $6.31 and opened (STO) a new June 2011 $240 Naked Put for $12.61, thus pocketing a profit on the May position of $3.74 ($374), and taking in a premium of $12.61 per contract ($1261) for the new June 2011 naked put.
Monday, April 25, 2011
Strangle - With a Twist
[caption id="" align="alignright" width="185" caption="Image via CrunchBase"]
[/caption]Recently, when Netflix (NFLX) reported earnings, the stock fell out of bed. It dropped like a stone, shaving about $50 off its then price. That was about a 20% drop in just a few days. Tonight NFLX is reporting earnings again, and I would like to position myself to profit in any direction the stock might go. The way to accomplish that is traditionally through what is known as a "Straddle," where one buys and sells a put and a call option with the same strike price and the same expiration date. With the stock currently at $250 (+/-), a straddle would be buying a $250 strike call and buying a $250 strike put. The greatest volatility and movement comes from the nearest expiration month, in this case, May 2011. With earnings coming out tonight, a May 20, 2011 expiration feels right. But buying a $250 call would cost $16.95, and a $250 put would cost $14.25, for a grand total of $31.20 per share, or $3120.00 for 1 contract of each (each contract controls 100 shares).
The idea is that by positioning yourself at the same strike price, if the stock falls, the put you bought will increase in price, while the call would decrease in price; while if the stock rallies, the call you bought would increase in price, while your put would decrease in price. You are looking for a sufficient increase in price to compensate for the entire position cost.
The Strangle is a variation on the straddle. Whereas the straddle encompasses a call and a put at the same strike price, the strangle is a position with prices that are not the same. Those prices can be either in the money (ITM) or out of the money (OTM). The expiration date is the same.
Here is what I did:
Bull Put Spread
I bought to open (BTO) a May $235 put = $8.25I sold to open (STO) a May $240 put = $10.05CREDIT $1.80-and-
Bull Call Spread
I bought to open (BTO) a May $260 call = $11.63I sold to open (STO) a May $265 call = $9.75DEBIT $1.88NET DEBIT $.08 plus commissions
Notice that both are bullish positions: The Bull Call Spread from $260-$265, and the Bull Put Spread from $235-$240. Both of these spreads are said to be out of the money (OTM) (refer to previous blogs for definition). If NFLX rallies, the Bull Put Spread will expire worthless, and I will pocket $1.80, and will be able to sell to close (STC) my Bull Call Spread at $5 less my debit of $1.88 for a total gain of $3.12.
But the main reason I put on those positions is because it costs me very little, and I can modify the legs of either spread should there be a dramatic movement in the stock.
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