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.

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