Friday, May 31, 2013

an investing business model using aapl mini-puts

last week i shorted a mini put on aapl. this trade was successful and the option lost value enabling me to keep the premium.


i could have let the option expire worthless and just keep the premium but a one-off trade like this is not terribly interesting. the interesting thing about short puts is that they are the gateway to the calendar manufacturing business. on thursday i inaugerated my aapl mini-calendar manufacturing business by buying back my may5 435 mini-put and selling the jun1 435 mini-put as a single transaction. here's my trade history for the week:


the first transaction in this list is the calendar that i sold for a profit of $2.33. my manufacturing cost for this financial product amounts to .30 - my brokers commissions for buying and selling the two option contracts. in the calculus of mini options this realized $20.30 (paid to my account at clob, not 3 days later.) i am totally serious when i say that i made 766% (=2.33/.30) profit on this transaction. i fully expect to repeat this transaction next thursday and weekly ad infinitem.

a business this good should be grown and that is the idea of the last three transactions. on 5/31 aapl moved up into the high $450 handle. when aapl happened to be at its high point for the day i purchased three aug 290 strike mini-puts for .20 and sold two additional jun1 435 mini-puts. this created what is known as a diagonal - an option trade where one owns far-dated options and shorts near-dated options at a different strike. the 290 strike was chosen because it is equal to about 2/3 of the 435 strike. this keeps the buying power allocated to these three mini-options level with the previously cash-covered, short mini-put and adds just .035 (=(.20 + .15)/10,  there are 10 weekly roll opportunities between june and august and $1.5 commission on purchase) to the manufacturing cost of producing weekly mini calendars. thus, i have tripled the size of this admittedly small business with no additional risk.


Monday, May 27, 2013

mini-options are a smalldog investor's friend

from time to time i feature a position in my portfolio. here is my aapl position:

short a mini-put on aapl
mini-options control 10 shares of an underlying equity instead of  the usual 100. they are brand new and are only available on 5 equities (goog, aapl, amzn, spy and gld) other than the multiplier being different they look and price exactly the same, you just need to get used to mentally shifting the decimal 1 position instead of 2. my position statement says that i sold this option for $2.93 which means i collected $29.30 for the allocation of $4,350 of buying power in my ira for this week (annualized return of 35%.) the regular option would 10 times all of that but the buying power hit would not conform to my size restrictions. this is a position that i plan to roll week-to-week. mad-money host jim cramer is always saying one should divide by 10 when thinking about these high priced stocks and now there's a mechanism to do just that.

Saturday, May 25, 2013

rolling thoughts

the unique characteristic of options is that they use market forces to assign a value to time. when you buy a stock the price is the same whether one plans to hold forever or a month or 2 minutes. not so with options. all else being the same, an option with 40 dte (days to expiration) is more highly valued than a 10 dte option. this is because the value at expiration, what is called intrinsic value, of a 40 dte option has a greater chance for improvement than a 10 dte option. market forces assure this relationship otherwise one could buy the long-term option and sell the near-term option and realize at least the difference simply by waiting out the near-term (and probably a good deal more!)

the way that time is valued by the options market is not a straight-line relationship. an option with twice as much dte is valued less than twice as much. quite a bit less. the multiple is about 1.4. why 1.4? well, 1.414 is the square root of 2. the well-known relationship is: the time value of an option is proportional to the square-root of remaining time. here's the graph of this relationship:

how i think about this relationship is that there is a built-in bulk discount for time in the options market. one can purchase four times as much option dte for only twice the price.

the way that i most commonly use this relationship is deciding when to roll a shorted-option. when there are 10 dte left in an option there are about 40 dte in the next monthly expiration. it is at this time that i begin pricing the roll value. i set up the roll transaction in the thinkorswim platform which will price the mark (mid-bid/ask price) difference between the near-term option i am buying and the far term option i am selling. then i compare this roll credit with the extrinsic value of the near term option (it does not matter if the option is in or out of the money.) if the roll credit is more than twice the extrinsic value of the near term option then i execute the trade.  otherwise it pays to wait for a better price now than later; two or more in the bush are worth the bird in hand! of course, this relationship may obtain earlier or later than 10 dte, depending on how far price has moved away from the strike price and whether or not there are corporate events in the time frame under consideration.

this is not to say that rolling short-options is always a profitable event. sometimes it is not possible to even get enough credit to cover the commissions. if there is a dividend due in the far month the roll may price negatively because the payment to stockholders is priced into options (but this only affects calls.) most often a lousy roll credit is due simply to the fact that markets move and the underlying is no longer trading close enough to the strike. rolling with the grain (rolling-up a short-put to a higher strike or a short-call down to a lower strike) adjusts the short strike closer to the money with a credit and is not a problem. however, if the underlying price has moved against your short option and there is a lousy roll credit then there is a judgement call one has to make - is this particular underlying worth continuing to sell premium on? rolling against the grain will require one to pay money instead of collecting it (albeit less than the strike differential) and closing the option might realize a net loss. the way i think about this is asking: am i following the money to a richer hunting ground? are the credits i collect in future rolls likely to be better? generally it is the case that option premiums are richer when a stock sells off. this is because fear is stronger than greed and people will pay-up to buy puts. my personal rule of thumb is that it pays to roll-down a shorted-put but not to roll-up a shorted-call. rolling down a short-put realizes a smaller loss than simply closing the option because the option being sold in the next expiration has extrinsic value. if you are then assigned you will have a lower cost-basis than you had before the down-roll, although maybe not as low as the strike you rolled to.

a shorted-put gone bad means price has declined but implied volatility has probably increased. thus i pay to roll down the strike of the put to anticipate richer roll credits in the future. it is not, however, necessary to roll all the way down to an otm strike. pick a strike that is at-the-money or in-the-money. this is because, the extrinsic value of an option is dictated by its proximity to the underlying's price - it trails off in both directions- and it will cost less to get down to an itm strike.








Wednesday, May 22, 2013

my bullish trade on slw

trading along with rachel fox i decided to take a bullish trade on slw. however, i deployed a different strategy than her. here's what i did - i sold short 1 june put at the $22 strike. here's the profit and loss graph for this trade:



slw short put (click image for closer view)
this graph simply says that i have about a 68% chance of this short put being worth less money at expiration than what i sold it for.

i do not directly own any shares of slw. i sold short a jun 22 put for a credit of 70 cents. this means i am obligated buy the shares for $22 if the counterparty on that option should choose to exercise. if an exercise occurs i would then directly own 100 shares of slw for a cost basis of $21.30 and i am good with that. my broker has allocated $2,130 of buying power from my ira to ensure i have the funds to work that transaction should an exercise occur.

q: so what if the stock sells off? are you able to make more money?

a: short answer, yes, i can collect additional credits even though the option is in-the-money. if the stock sells off to say, 20, by the june expiration on 6/21, then the june 22 put becomes worth $2, once the time value burns off. i could just let the option expire and take posession of the shares through the process of automatic exercise. however, this is not my first choice. i'd rather buy back the option and sell that very same put in the july expiration. buying an option in one month and selling an option in the next month is called rolling. because time-is-money the july 22 put will always be worth more than the june 22 put and thus exchanging june for july will generate a credit. this credit will be greatest the closer slw's price is to 22 when i roll. buying and selling the same option in two different expirations is also called a calendar. using the theoretical pricing feature of the thinkorswim trading platform i can estimate that i would get .38 for the roll when slw sells off to 20 on june 21 (assuming an additional 3% of implied volatility):



estimated roll credit for slw jun 22 put (click image for a closer view)
this is an iterative process. by rolling the option month-to-month (or week-to-week, slw has weekly options) i realize cash profit every month. these profits accumulate until the counter-party chooses to exercise early, which is no big deal because all of the roll credits accumulate to reduce the cost basis.

Monday, May 20, 2013

covered call playbook: rescuing a losing stock trade


here's a real trade in distress: long slw stock at 23.70 (you know who you are) and sold the jun 23 calls for .62/share (ok this part is fiction, but was proposed.) now slw is trading at 23.18. the trade looks like this in the analyze tab:


slw covered call simulation

the shares of slw were acquired previously then the stock went down. a call was sold against the shares to lower the cost basis and rescue a losing trade. then slw went up above the 23 strike and it now appears that the best we can do is scratch this trade.

appearances can be deceiving.

here's the play:
  • wait til there about 10 days left in the expiration period. at the 10 day mark there is about 40 days to go in the july expiration or 4 times as much time. at that time it is likely that the july option will price for about twice the june option. this is due to the well-known property that option time-value decays directly proportional to the square-root of remaining time and since there is 4 times as much time to go in july than in june, a double is likely because the square-root of 4 is 2. 
  • compare the extrinsic value in the june 23 calls to the roll credit. set up, but don't execute a trade to buy back the june 23 calls and sell the july 23 calls.
  • if the july roll credit is at least twice the extrinsic value of the june call then execute the trade, otherwise re-evaluate the next day. the idea is that if there is way more money to be made in the july expiry it doesn't make sense to hang on to june.
  • the roll credit further reduces the cost-basis. the closer slw is to 23 at roll-time, the greater the credit will be.
  • lather, rinse and repeat next month.


so what if slw is trading up around 30 or so when it is time to roll, won't i miss out on $7 of profit?

not necessarily, here's the play:
  • roll the call horizontally to the next expiration (as above.) if the roll credit does not produce adequate gain then close the trade (or take automatic assignment at expiration - the $15 assignment charge may be a savings over closing transaction costs.)  stay uninvested in this equity and wait for a dip to short puts.
6/3/13 revision note: previously i suggested spending money to roll to a higher strike. upon, some further reflection, i think this is not money well spent because implied volatility generally contracts as prices rise. an exception could occur for short-squeezes, where panicky shorts may cause price and iv to lift together.

Sunday, May 19, 2013

omg, i was wrong on fx

there's a blog headline you won't see from other pundits. i was wrong on my call on the eur/jpy. shortly after i acquired that position the bank of japan decided to go whole-hog into their own extraordinary quantitative easing program, thus causing the jpy to fall and the dollar to strengthen. i was wrong, but for the right reasons. i think there was every reasonable expectation that the usual seasonality would obtain. however, things were demonstrably different on this go-round and i have the bruises to prove it. the $600 (of $3000) that i managed claw back from the market has been reduced to $200. no matter, this account had been as low as $50.

with some detached amusement, i am also wrong on the aud/usd. i say detached because i had liquidated my long aud/usd position to acquire the eur/jpy short position. the aud/usd is getting anhilated, now down in the .97 area after spending considerable time in the 1.05 area. this is largely due to dollar strength, which produces weakness in metal commodities such as gold, because all such commodities are transacted in usd.

short interest on aud/usd is likely to be short lived. this is because shorts are paying disproportionate amounts in roll-over rates to stay short. the daily rollover on aud/usd short costs about 1.30 per mini, whereas the daily rollover on long aud/usd pays .50 per mini. so when aud/usd stabilizes around some lower price, i don't think the aud/usd bears will stay around to watch their profits erode, but, as i already admit, i was wrong on the current call.