Sunday, December 29, 2013

when it pays to pay-to-roll

one of the premium seller's commandments liz and jny of tastytrade make is "never pay to roll an option." this is dubious advice, imho. in my experience, paying to roll a short option almost always improves your position's p&l. so i'd like to make the pro-argument in the pay-to-roll debate.

here's a hypothetical based on the real life equity CME:


one week back cme was riding high - made a new 3 year high. suppose we had decided to sell the 84 put expiring in january that week on dec 18. according to the thinkback we would have gotten $3.05 of credit to sell that put:

that was then, dec 18

were that so our cost-basis in the shares would be 80.95 (=84-3.05) and our broker would set aside $8095 per contract of buying power in a non-margin account to purchase the shares should we be assigned.

now flash-forward to today - cme paid a special dividend of 2.60 and sold off to  78.91:

this is now, dec 29

here's what one can do in this situation: buy back the jan puts and sell the feb 77.5 puts for $3.05 debit, giving back all the credit we took in on dec18. however, now our cost basis becomes 77.5 (+2 commissions), $3.45 lower than $80.95 we had before. moreover, we actually recover $345/contract of buying power (not lose $305/contract!) of buying power, since now we only have to set aside $7750/contract of buying power to buy the shares.

why wouldn't you do that!?

if we had simply bought the shares on dec 18 for 84.64 we would now be smoking hopium looking at a $5.77 loss and waiting for the $2.60 dividend payout to lessen the pain. while this special dividend situation is somewhat unusual it is not unusual to be able roll a short put diagonally down with a drop and recover more buying power than paid out while at the same time lowering cost basis.




Thursday, December 26, 2013

frisky dogs of the dow

one of the first investment strategies i took seriously was the venerable dogs of the dow strategy. in that strategy one buys equal dollar amounts of stock of the top-ten dividend payers in the dow. this is done at the beginning of the year which is why you might be hearing about it in the media once again. there is at least one variant of this strategy that i also once took seriously: the small dogs of the dow. in the small dogs of the dow one invests in only the 5 lowest priced dogs of the dow. to be sure, i borrowed the appellation for the title of this blog.

now, after being steeped in option selling techniques i would like to propose a new strategy of investing in dow stocks that is based on option metrics: frisky dogs of the dow. in the frisky dogs strategy i select the ten dow stocks with the highest implied volatility percent range (or iv percentile, or iv rank as it is variously known in the haunts i frequent.) iv%r tells you where in last 52 week range the current implied volatility lies. stocks with a high iv%r are more active and usually this is because they have recently sold off, thus they are dogs. 

here is the current list of frisky-dogs listed in small dog order:

my idea is that one should short puts on some or all of these stocks starting in january and roll them from month to month to take advantage of time-decay. at the end of 2014, a new list is generated indicating which stocks are to be added or removed from the portfolio. i would drop the smallest frisky-dog, csco, as it does not pay a good enough premium relative to my commission structure.

happy new year to all.





Saturday, December 21, 2013

how now dow?

every once in a while i trot out my dow/gold ratio chart to see where the economy has gotten to. here's the image:


this ratio purports to measure the value of the stock market in terms of what is considered to be a stable store of value: gold. economists like this sort of chart because it automatically corrects for inflationary effects. a side-effect is that it also corrects for distortions that flow from central bank monetary policies and political policies that fixed the price of gold (such as existed from FDR to Nixon administrations.) historically, this ratio tends toward a value of 20. in exceptionally bad times the number goes into the single digits, in exceptionally good times the number goes into the 30's and 40's. however, i can only produce a chart of the last 20 years in thinkorswim.

as it stands, the ratio has broken into the teenager range that existed prior to the 2008-9 bubble-burst. my expectations are that the ratio could spend some time in the 13-15 range. the probability is good that we will see multiple tests of the 15 level before breaking through. one might consider a pairs trade to short gold and buy the dow.