Thursday, September 29, 2011

nearly naked diagonals

Me: Mom, the rolls are gravy!
Mom: Well, which is it, dear. Rolls or gravy?
Me: No, no, the rolls are gravy!
Mom: (sigh)
Back in June I wrote about a strategy I call the nearly naked put - a vertical spread with the twist that the long option is purchased WOTM (way out of the money,) a measure that conserves buying power. This is an effective strategy for a non-margin account (but not limited to) where you want to sell a naked-put but want to reduce the allocation of buying power to be more in line with a margin account.

So, now I evolve this strategy a little - I purchase more time on the long option than the short option. See, I want to repeat the NNP on the next cycle but that would mean purchasing yet another WOTM option and while they are cheap enough out there, the repeated commissions and purchase price do reduce profitability a bit. The evolutionary idea here is that by purchasing the WOTM option a couple or three expiration cycles out I get a kind of two-fer, I pay 1/2 to 1/3 the commissions on it and I get the bulk-rate discount on time according to the well-known mathematics of option pricing (whereby price is proportional to the square-root of remaining time e.g. one can buy 4x time for only 2x price.) I call this strategy the nearly naked diagonal or NND.
The Rolls Are Gravy
The goal of the NND is to use time as an edge to produce reliable profits, even (nay, especially) in very difficult trading conditions. This is accomplished as time is winding down on the short options in a trade called a calendar roll. As I discussed previously (in the twilight zone roll) the calendar roll almost always generates a credit due to the mathematics of pricing time into options. The NND goes on for a small credit or debit but then every roll is pure gravy.

Tell that to your Mom at dinner.



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