Friday, September 14, 2012

new rules: stock-straddles

  • initiate stock-straddle trades only. that is, long stock and short the straddle  (short the call and short the put at the same strike.)  i sell the straddle in the back month.
  • trade only unlevered, liquid etf's with liquid options. unlevered etf's have low risk of going to zero and other adverse corporate events. this strategy relies on future expiration cycles perpetually being available.  levered etf's suffer from the death spiral syndrome whereby they never seem to recover in price even though the underlying index does. the back month atm options must have a narrow (like 15 cents or less) bid-ask spread and must have a couple hundred or more contracts of open interest. the underlying etf must trade 500,000 or more shares/day. it is interesting to note that most etf's satisfying the volume requirement also satisfy the liquid option requirement.
  • prefer etf's with a high volatility index. the emphasis is to make money on selling premium and the options aren't going to sell for much if the vol is low. although, low vol is not a reason to quit one of these trades.
  • roll eligible options as soon as the extrinsic value is worth less than the roll value. the options become eligible for rolling when they age into the front month. this way the extrinsic value is constantly being tacked on to the back month and the risk of early exercise minimal. this rule applies equally well to both the itm as well as the otm options.
  • keep a gtc order to buy-back the options for a nickle. if these execute then sell the 30 delta options to complete a vertical roll. the trade may evolve into a stock-strangle trade but that's ok.
  • control the beta-weighted delta with stock-straddle trades on sh and vxx. stock-straddle trades are neutral-bullish so a portfolio of these can cause your net-liq to sag when the market retreats. sh is a bearish etf on the s&p 500 which meets my selection criteria. vxx is an etf that trades vix futures and though it is not explicitly a bearish etf, it does create negative beta-weighted delta.

the first principle that makes these stock-straddle trades work is the statistical fact that the highest probability of future price is the current price. thus the probabilities favor time-decay of the short options. being short a call and a put guarantees that at least one of the options will be profitable.

the second principal stock- straddles stand upon is the addage: time-is-money. thus, a short option that has appreciated can be rolled to some future expiration for a credit in all but the most extenuating circumstances. such circumstances could only occur in a stock paying a large one-time dividend and that is a rare occurrence for stocks  and more so in the etf world.

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