Saturday, November 30, 2013

how options give smalldog investors the bigdog advantage

one of the benefits of trading options is that they are levered products. in a stock replacement strategy the typical procedure is to buy a 70 delta call option in an expiration that is 90 or more days away. one typically pays less than 1/3 of the price of buying the shares with that method. the question is: how much leverage does that represent? the answer may surprise you but first i need to develop the concept of option leverage a little.

the key to understanding option leverage is thinking about delta in a different way. the definition of delta is that it describes the relationship between option price movement and the underlying equity's price movement. in a 70 delta option, a one dollar move in the equity leads to a 70 cent move in the option. however, an equally valid way to think about delta is that a 70 delta option gives you 100% of the performance of 70 shares of stock. so to figure the leverage of a 70 delta option one simply needs to compare the price of the option to the cost of purchasing 70 shares of stock or: 

delta * equity price / option price

thus, our 70 delta option purchased at 1/3 the price of the stock equals leverage of 2.1 (=.7*3)  - about the same leverage you get with a typical margin account where you put up 50% of the buying power (but without the sec looking over your shoulder!)

now, there is a special kind of margin account called a portfolio margin account that is only available to bigger dogs than me who can put together $100K in a non-retirement account. in a portfolio margin account one only puts-up buying power equal to 5% of the cost of the stock purchase, or leverage equal to about 20. so the question is can a smalldog stock-replacement trader achieve this same advantage?

yes! one can, but one needs to be a little less rigid about selection. here's the option chain on spy for the feb14 expiration (about 90days-to-expiration) with the mark (mid bid-ask) price and delta displayed:



the first strike (180) in-the-money, has a leverage of 21.6 (= .53 * 181 / 4.45 ) and the 2nd strike (179) itm  has a leverage of 20.4 (=.57*181/5.05). however, this 57 delta option is a little low for many stock replacement traders.

you see, another interpretation of delta is that it is approximately equal to the probability of expiring in-the-money and a 57% chance, though better than a coin flip, is playing a little too close to the edge. however, one can increase the delta by accepting fewer dte and still achieve 20x leverage. here's a look at the jan14 with 48 dte:



i calculate that the 175 strike call has a leverage of 20.2 (=.77*181/6.905) and is right smack in the middle of the 70 delta range coveted by stock replacement traders.

so who needs portfolio margin!?


Monday, November 25, 2013

thinkscript_included: sdi_ivpls - the popular iv rank (aka percentile) as a lower study

following on the succes of the popular iv rank, or percentile as it was originally called, there have been requests to show the graph of the indicator. simple enough, so here's the image of this new lower study called sdi_ivpls:


and here's the code:


################################
# sdi_ivpls: Display Implied Volatility Percentile as a lower study
#hint: Displays the Implied Volatility Percentile as a chart lower study. sdi_ivpls rev: 1.0 http://www.smallDogInvestor.com
# author: allen everhart
# date: 11/25/2013
# copylefts reserved. This is free software. That means you are free
# to use or modify it for your own usage but not for resale.
# Help me get the word out about my blog by keeping this header
# in place.
declare lower;
input period = AggregationPeriod.DAY ;
#hint period: time period to use for aggregating implied volatility. sdi_ivpls rev: 1.0 http://www.smallDogInvestor.com
input length =252 ;
#hint length: #bars to use in implied volatility calculation.
def ivGapHi = if isnan(imp_volatility(period=period)) then 99999999999 else imp_volatility(period=period);
def ivGapLo = if isnan(imp_volatility(period=period)) then -99999999999 else imp_volatility(period=period);
def periodHigh = highest( ivGapLo,length=length);
def periodLow = lowest( ivGapHi, length=length);
def ivRange = periodHigh - periodLow ;
def ivp = round( 100*(imp_volatility(period=period) - periodLow)/ivRange, 0);
#plot labelColor = 0; # only to pull in color select widget
#labelColor.setHiding(1) ; #never want to show this
#labelColor.hideBubble();
#labelColor.hideTitle();
#labelColor.setDefaultColor(color.PLUM);
#AddLabel(1, Concat("IV%: ", ivp), labelColor.takeValueColor() );
plot ivpr=ivp;
ivpr.setDefaultColor(color.PLUM);
####################################

Sunday, November 17, 2013

thinkscript included: release 1.2.0 of sdi_aispy

this version of my aispy strategy corrects the p&l of the for the effects of commissions. i do this by slipping the purchase prices by the round-trip cost of commissions per share.  here is a picture of this strategy in comparison to the passive strategies of buy 'n hold and dollar-cost-averaging:


aispy rev 1.2.0 ,10 year comparison with buy and hold

as always, the updated version is published on the original blog post which you can find here.

correcting for commissions this strategy is showing underperformance relative to buy 'n hold but a significant overperformance relative to dollar-cost-averaging. to my mind the comparison to dca is more appropriate and realistic. however, my question to you, the reader, is who really engages in buy 'n hold? doesn't that presume you are in possession of your entire life savings at an early age,  go all-in, and never add!?