Well, I certainly could have picked a better option trade to test this... knowing a little more each day sometimes makes me shake my head at previous decisions...especially when they are still in play.
Review:
CAH Jan 35 put for $2.50, Delta = 0.389, OTM by 63 cents
CAH Jan 35 call for $2.85, Delta = 0.62, ITM by 63 cents
The EV on the puts (100%) was a bit higher so that should lead me to believe that traders consider a drop in price more likely. Even according to my charting I would have bought a put or just shorted the stock at $35.50 had I not been wanting to try this style of trade.
Currently:
CAH Jan 35 put for $2.95, Delta = 0.46, ITM by 74 cents
CAH Jan 35 call for $2.85, Delta = 0.524, OTM by 74 cents
So I am up 45 cents on the put and down 90 cents on the call for a net loss of 35 cents. If the Delta holds true then the rate of decline in the call is reducing and the rate of increase in the put is increasing...assuming that the price of the stock actually continues down.
I expect to hold the put and, if the price jumps today, I may close my call at a smaller loss than appears right now.
Jeff.
Questrade, My direct access discount broker.
Monday, August 31, 2009
Friday, August 28, 2009
Current positions
I have a number of positions in play right now, sold one for just over a 30% gain, not bad for a week and change, another for 3.1%. I consider those not bad for the timeframe involved.
I added two more today, one I have held before as a stock I now bought the call option, AEO and a new one, COP. Both have been on my main list. COP was to be a short play but the downtrend line was broken and may become support so I entered an call option trade for a higher price than I might normally.
I have been introduced to an option trade that I really like but cannot yet take advantage of due to capital requirements (multiple small account syndrome). I'm not certain what it is called but the idea is to buy the call option at the money or the next out of the money for the bullish play, this can be done on it's own but I would rather buy in the money calls if that were the case.
The second trade is to sell the next strike or two out of the money put. The idea is that the price is expected to go up therefore the call option is a fair trade on it's own but selling the put below the current price gives some compensation for the cheap near the money call effectively reducing the initial cost of the trade. Of course should the stock price plummet the put could be exercised and I would be obligated to buy the stock at the strike price...I could buy the put back when it approached the strike price to remove my obligation and not get stuck with the stock though.
This play just reduces the cost of the call option up front and effectively super leverages the capital as the two trades are taken as one. It also assumes that the put is worth selling so there must be some sort of expectation of volatility enough to justify someone betting that the price will drop.
I would stop both trades somewhere in case I were wrong about the overall stock movement.
Jeff.
I added two more today, one I have held before as a stock I now bought the call option, AEO and a new one, COP. Both have been on my main list. COP was to be a short play but the downtrend line was broken and may become support so I entered an call option trade for a higher price than I might normally.
I have been introduced to an option trade that I really like but cannot yet take advantage of due to capital requirements (multiple small account syndrome). I'm not certain what it is called but the idea is to buy the call option at the money or the next out of the money for the bullish play, this can be done on it's own but I would rather buy in the money calls if that were the case.
The second trade is to sell the next strike or two out of the money put. The idea is that the price is expected to go up therefore the call option is a fair trade on it's own but selling the put below the current price gives some compensation for the cheap near the money call effectively reducing the initial cost of the trade. Of course should the stock price plummet the put could be exercised and I would be obligated to buy the stock at the strike price...I could buy the put back when it approached the strike price to remove my obligation and not get stuck with the stock though.
This play just reduces the cost of the call option up front and effectively super leverages the capital as the two trades are taken as one. It also assumes that the put is worth selling so there must be some sort of expectation of volatility enough to justify someone betting that the price will drop.
I would stop both trades somewhere in case I were wrong about the overall stock movement.
Jeff.
Setting option stop loss prices
I decided to pop this into a separate post, I get carried away with posts and they tend to meander from topic to topic as my thought processes hit upon various aspects that appear as I write. I don't mind this so much as this is mostly for me to clear my mind and get some of this stuff down rather than for public consumption...any who can follow along, great.
Previously I mentioned considering the Extrinsic Value as a slush amount. Basically, with regards to setting the initial worst case stop loss price, the EV should be discounted wholly and use the Intrinsic Value only. This would be done by taking the difference between the stock price when the option was purchased and the stock price that would be used as a stop in a standard trade and apply that to the IV of the option.
So an option at $10 with and IV of $8.50 and an EV of $1.50 leaves the $1.50 off the table. If the stock was trading at $30 and the stop would be at $27, apply that to the IV which puts the worst case stop at $5.50. A total potential loss of $4.50 per contract. Sounds high as this represents a 45% loss.
Keep in mind that this is only to allow the option room to move. If the stock plummets (assuming a call option is purchased) then this is not necessarily a bad deal. I would exit the option trade at the point when the stock reaches it's stop setting of $27 and I honestly expect that the option will still have some EV left so the loss is not likely as great as it appears.
More reasoning.
It would be a shame if the stock volatility dropped off, like the IPI example, causing the option to get taken out before the stock moved. In the IPI case the stock price went up 20 cps while the option dropped 50 cps. I will not close my option position when the stock is not even dropping.
In my case I hold both the option AND the stock so a drop in price AND volatility will hit me twice as hard...but this is an experiment.
This leads to another question.
Is it fair to consider the standard loss allowances used for stock trading to apply to options trading?
That depends.
Assume a 2% capital loss allowance per trade. On a $20K account that is $400 per trade risked.
My IPI trade was for $6.40, IV of $4.40, EV of $2.00. My stop loss allowance on IPI stock would be $2.50...that makes a total of $4.50 risked (EV + Stoploss). Worst case.
So I would set my initial stop at $1.90. (Option - EV - Stoploss) ... OUCH!
A more recent trade example.... AEO.
Option purchased for $4.40, stock price of $14.10.
IV = $4.10 EV = $0.30 (6.7%)
Stop on the stock = $13.00 ($1.10 stoploss)
4.40 - 0.30 - 1.10 = $3.00
Total risk = $300 or 1.5% for the $20K account.
So, yes it is reasonable to apply the standard loss allowances. The problem comes into play with larger stock prices. A $14.00 stock may have a comfortable loss setting at $13 or so but a $50 will be a larger difference...so this is mitigated in trading by using smaller positions, 50 or 25 shares. In options the minimum contract size represents 100 shares.
This gets me into buying the At The Money (ATM) options and this is also where a lot of people lose a lot of cash.
A cheap option that is Out of The Money (OTM) might cost 30 cents. One contract cost $30...WOW, I could buy 100 contracts for the same as 100 shares of the same stock trading at $30. Problem is that the ENTIRE option cost is risked as opposed to the stop loss on the stock of perhaps $300.
Being right is great in that kind of a case, being wrong sucks.
Go by the worst case loss rather than even the potential gain for position sizing and I would expect that using the same share size as stock size is best of the start. I have a couple OTM options that I have bought 4 contracts but I know that I risk every penny...I likely would still get out with some cash left if it goes sour but a few of these sorts of trades are not a bad idea if the risk is known, and acceptable.
I think I rambled enough for today.
Jeff.
Previously I mentioned considering the Extrinsic Value as a slush amount. Basically, with regards to setting the initial worst case stop loss price, the EV should be discounted wholly and use the Intrinsic Value only. This would be done by taking the difference between the stock price when the option was purchased and the stock price that would be used as a stop in a standard trade and apply that to the IV of the option.
So an option at $10 with and IV of $8.50 and an EV of $1.50 leaves the $1.50 off the table. If the stock was trading at $30 and the stop would be at $27, apply that to the IV which puts the worst case stop at $5.50. A total potential loss of $4.50 per contract. Sounds high as this represents a 45% loss.
Keep in mind that this is only to allow the option room to move. If the stock plummets (assuming a call option is purchased) then this is not necessarily a bad deal. I would exit the option trade at the point when the stock reaches it's stop setting of $27 and I honestly expect that the option will still have some EV left so the loss is not likely as great as it appears.
More reasoning.
It would be a shame if the stock volatility dropped off, like the IPI example, causing the option to get taken out before the stock moved. In the IPI case the stock price went up 20 cps while the option dropped 50 cps. I will not close my option position when the stock is not even dropping.
In my case I hold both the option AND the stock so a drop in price AND volatility will hit me twice as hard...but this is an experiment.
This leads to another question.
Is it fair to consider the standard loss allowances used for stock trading to apply to options trading?
That depends.
Assume a 2% capital loss allowance per trade. On a $20K account that is $400 per trade risked.
My IPI trade was for $6.40, IV of $4.40, EV of $2.00. My stop loss allowance on IPI stock would be $2.50...that makes a total of $4.50 risked (EV + Stoploss). Worst case.
So I would set my initial stop at $1.90. (Option - EV - Stoploss) ... OUCH!
A more recent trade example.... AEO.
Option purchased for $4.40, stock price of $14.10.
IV = $4.10 EV = $0.30 (6.7%)
Stop on the stock = $13.00 ($1.10 stoploss)
4.40 - 0.30 - 1.10 = $3.00
Total risk = $300 or 1.5% for the $20K account.
So, yes it is reasonable to apply the standard loss allowances. The problem comes into play with larger stock prices. A $14.00 stock may have a comfortable loss setting at $13 or so but a $50 will be a larger difference...so this is mitigated in trading by using smaller positions, 50 or 25 shares. In options the minimum contract size represents 100 shares.
This gets me into buying the At The Money (ATM) options and this is also where a lot of people lose a lot of cash.
A cheap option that is Out of The Money (OTM) might cost 30 cents. One contract cost $30...WOW, I could buy 100 contracts for the same as 100 shares of the same stock trading at $30. Problem is that the ENTIRE option cost is risked as opposed to the stop loss on the stock of perhaps $300.
Being right is great in that kind of a case, being wrong sucks.
Go by the worst case loss rather than even the potential gain for position sizing and I would expect that using the same share size as stock size is best of the start. I have a couple OTM options that I have bought 4 contracts but I know that I risk every penny...I likely would still get out with some cash left if it goes sour but a few of these sorts of trades are not a bad idea if the risk is known, and acceptable.
I think I rambled enough for today.
Jeff.
IPI options execution update
The importance of buying options with a small percentage of Extrinsic Value and considering that EV amount to be slush.
Back on the 19th of August I placed a trade for IPI stock and the Jan 20 call option. Here was the table as the trade stood at the end of that day. Note the EV of $2. Even on this short timeframe the EV lost far more than I might have expected.
Now, keep in mind this is a little experiment to compare the two trading vehicles and I am not expecting any real profits other than gaining some more knowledge in the realm of option trading. My expectations going in were curious in nature.
Here is the table for today:
The major thing to note on this one so far is that the stock is up 20 cps and the option is down 50 cps. Basically the intrinsic value is up by the 20cps of the stock but the extrinsic value dropped by 70 cps.. even though the Delta would suggest that a 20cps gain SHOULD result in a 16cps gain in the option value. The greeks are definitely not infallible.
Here is the daily six month chart for IPI :
The indicators that I have on the bottom are the Relative Strength Index and the Average True Range. The price is obviously in a bit of a limbo right now as it waffles around the long Volume by Price bar between $25 and $26. This bar looks to be more related to indecision than any support or resistance levels.
The ATR is just the average daily range over the last 5 day period and reflects a lower volatility. I could use other volatility indicators but this one also gives me a guideline for setting stop orders or VTSOs should I decide to employ them.
Seeing as the ATR is getting lower it would imply that the EV of the option should also drop in sync with this indicator. I was not tracking it but I expect that even the put EV is dropping as either option gets some of it's EV from this volatility. I knew this already but seeing it act on my money is a very interesting experiment.
This will affect how I place my stops for options trades. I should be wary of placing stops based on the option price as compared with the stock price at the time of the trade. This is why it is important to look for options that have a smaller percentage of EV as this value is not strictly a time value as option "guru's" would have us believe. Sadly, in this case, the option purchased was not the best deal as the EV was over 30% of the option price...that's a lot of slush.
Basically, the stop is more dependent upon the price of the stock than the price of the option. This is more important as the EV% gets higher. Perhaps a good way to set an option stop, rather than trying to accommodate the Delta and EV would be to completely ignore the EV and base the ultimate option stop upon the IV only. So if the stop on the stock, had a regular stock been purchased, was $3 lower than the price, the option stop should be the option purchase price minus the EV minus the $3. This writes of the EV as a variable that may cause the option price to be higher initially, a sudden drop in volatility with the associated EV drop could hit a well placed option stop inadvertently.
Write off the EV, use the stock stop difference and set this as the absolute worst case stop loss order for the option. Once it is in the money and there are profits to protect, the stop can be moved up or the option sold to crystallize these paper profits.
Options trades I look for now generally have an EV of less than 20% with the exception of trades that I may take that are out of the money...in which case I consider the entire premium as a potential loss, even though I know that there will usually be SOME value left in the option if I get rid of it before the last three months to expiration. I have one down around 7%.
Options are somewhat more complicated as this brings up another consideration.
Is it fair to use the same loss allowance for options as for stock trades?
Jeff.
Back on the 19th of August I placed a trade for IPI stock and the Jan 20 call option. Here was the table as the trade stood at the end of that day. Note the EV of $2. Even on this short timeframe the EV lost far more than I might have expected.
Now, keep in mind this is a little experiment to compare the two trading vehicles and I am not expecting any real profits other than gaining some more knowledge in the realm of option trading. My expectations going in were curious in nature.Here is the table for today:
The major thing to note on this one so far is that the stock is up 20 cps and the option is down 50 cps. Basically the intrinsic value is up by the 20cps of the stock but the extrinsic value dropped by 70 cps.. even though the Delta would suggest that a 20cps gain SHOULD result in a 16cps gain in the option value. The greeks are definitely not infallible.
Here is the daily six month chart for IPI :
The indicators that I have on the bottom are the Relative Strength Index and the Average True Range. The price is obviously in a bit of a limbo right now as it waffles around the long Volume by Price bar between $25 and $26. This bar looks to be more related to indecision than any support or resistance levels.
The ATR is just the average daily range over the last 5 day period and reflects a lower volatility. I could use other volatility indicators but this one also gives me a guideline for setting stop orders or VTSOs should I decide to employ them.
Seeing as the ATR is getting lower it would imply that the EV of the option should also drop in sync with this indicator. I was not tracking it but I expect that even the put EV is dropping as either option gets some of it's EV from this volatility. I knew this already but seeing it act on my money is a very interesting experiment.
This will affect how I place my stops for options trades. I should be wary of placing stops based on the option price as compared with the stock price at the time of the trade. This is why it is important to look for options that have a smaller percentage of EV as this value is not strictly a time value as option "guru's" would have us believe. Sadly, in this case, the option purchased was not the best deal as the EV was over 30% of the option price...that's a lot of slush.
Basically, the stop is more dependent upon the price of the stock than the price of the option. This is more important as the EV% gets higher. Perhaps a good way to set an option stop, rather than trying to accommodate the Delta and EV would be to completely ignore the EV and base the ultimate option stop upon the IV only. So if the stop on the stock, had a regular stock been purchased, was $3 lower than the price, the option stop should be the option purchase price minus the EV minus the $3. This writes of the EV as a variable that may cause the option price to be higher initially, a sudden drop in volatility with the associated EV drop could hit a well placed option stop inadvertently.
Write off the EV, use the stock stop difference and set this as the absolute worst case stop loss order for the option. Once it is in the money and there are profits to protect, the stop can be moved up or the option sold to crystallize these paper profits.
Options trades I look for now generally have an EV of less than 20% with the exception of trades that I may take that are out of the money...in which case I consider the entire premium as a potential loss, even though I know that there will usually be SOME value left in the option if I get rid of it before the last three months to expiration. I have one down around 7%.
Options are somewhat more complicated as this brings up another consideration.
Is it fair to use the same loss allowance for options as for stock trades?
Jeff.
Tuesday, August 25, 2009
Twist on covered calls.
I stumbled upon an interesting wrinkle in options trading that may prove to be very beneficial in the future.
I can currently buy calls and puts as they do not involve anything more risky than just losing the entire cost of the options.
Covered calls require owning the underlying stock and writing or selling calls (or puts) against this position in order to make money based on the premium which makes up the extrinsic value of the option.
Assume I have a stock at $30. I then sell the call option for the strike price of $35. The option sells for, say, $2. I put $200 per contract in my pocket. Total capital is $3500. possible loss is $3300...in theory.
1) The stock price goes up past the strike price and the option is exercised buying my stock for $35. Profit equals the gain on the stock for $5 ps plus the premium of $2 ps. Total profit is limited to, but realized at, $700
2) The stock price remains, more or less flat, or at least does not reach $35. Profit at option expiry is $200. I can sell another call option.
3) The stock price drops to $25. The call expires, $200 profit which offsets the $500 loss if I sold my stock so the final loss could be $300. Of course if the stock continues to drop the loss is larger but I'll assume a stop is in place...which I am not sure how that would work with an active covered call.
Here is the twist. Options are guaranteed to be exercisable, they are always good. So If I buy a call option with a long expiry on the above stock for a $25 strike, giving me the option to buy the stock in future for $25 it is as good as buying the stock outright at $25... but the option may only cost $7 ps... AND I sell a call option on the same stock with a strike of $35 for a $2 premium. Total capital of $500... this is also my maximum risk.
My numbers may be off but the idea is sound. I will run a real example another time to see if the costs are close, I expect that the call sold is not worth as much as $2...but it looks good.
1) The stock price raises past the covered call strike of $35, I exercise my $25 strike option to sell to the buyer at $35. Profit is $10ps plus the $2 ps premium or $1200
2) The price remains flatish. I keep the $200 and can sell another call.
3) The stock price drops to $25. I can sell my call for whatever extrinsic value is left and keep my $200 premium or consider that I have taken most of the loss already and sell another call option. Possible loss could be $300. I don't need to worry about stops as my total risk is small.
Limited risk and limited profit potential option trade.
There are quite a few ways to configure an options trade with two simultaneous trades, and even some with three that I have not looked at too closely yet.
All in all I think there is a trade that will suit almost any stock or market situation to have a decent opportunity to produce profits, even when the price of a stock does not move at all.
Jeff.
I can currently buy calls and puts as they do not involve anything more risky than just losing the entire cost of the options.
Covered calls require owning the underlying stock and writing or selling calls (or puts) against this position in order to make money based on the premium which makes up the extrinsic value of the option.
Assume I have a stock at $30. I then sell the call option for the strike price of $35. The option sells for, say, $2. I put $200 per contract in my pocket. Total capital is $3500. possible loss is $3300...in theory.
1) The stock price goes up past the strike price and the option is exercised buying my stock for $35. Profit equals the gain on the stock for $5 ps plus the premium of $2 ps. Total profit is limited to, but realized at, $700
2) The stock price remains, more or less flat, or at least does not reach $35. Profit at option expiry is $200. I can sell another call option.
3) The stock price drops to $25. The call expires, $200 profit which offsets the $500 loss if I sold my stock so the final loss could be $300. Of course if the stock continues to drop the loss is larger but I'll assume a stop is in place...which I am not sure how that would work with an active covered call.
Here is the twist. Options are guaranteed to be exercisable, they are always good. So If I buy a call option with a long expiry on the above stock for a $25 strike, giving me the option to buy the stock in future for $25 it is as good as buying the stock outright at $25... but the option may only cost $7 ps... AND I sell a call option on the same stock with a strike of $35 for a $2 premium. Total capital of $500... this is also my maximum risk.
My numbers may be off but the idea is sound. I will run a real example another time to see if the costs are close, I expect that the call sold is not worth as much as $2...but it looks good.
1) The stock price raises past the covered call strike of $35, I exercise my $25 strike option to sell to the buyer at $35. Profit is $10ps plus the $2 ps premium or $1200
2) The price remains flatish. I keep the $200 and can sell another call.
3) The stock price drops to $25. I can sell my call for whatever extrinsic value is left and keep my $200 premium or consider that I have taken most of the loss already and sell another call option. Possible loss could be $300. I don't need to worry about stops as my total risk is small.
Limited risk and limited profit potential option trade.
There are quite a few ways to configure an options trade with two simultaneous trades, and even some with three that I have not looked at too closely yet.
All in all I think there is a trade that will suit almost any stock or market situation to have a decent opportunity to produce profits, even when the price of a stock does not move at all.
Jeff.
Monday, August 24, 2009
Buy Low Sell High...
If only it were that easy.
I keep scouring the internet for new information or even a twist on something old...which is most of what is happening anyway.
I was reading an article that re-hashed the same thing that everyone says and everyone thinks it is their idea. I suppose even I am prone to this as here I am writing about it. The difference is this is more a blog than any information providing service.
Three trading "secrets"
1) make a plan and stick to it
2) cut your losers short
3) let your winners run
WHEW! now I know all there is to know about being successful in trading.
Now, I've only been at this for ...close to a two years now and those were probably the first "Rules of Trading" that I ran across. They do make perfect sense.
This is a timely bit of self talk for me today as my positions are doing quite well, nothing too huge, just quite well. My trades are all between -1.6% and +30% on paper right now and the overall average is 8.5%. Not bad for a couple of weeks playing.
Where the timing comes in here is that I was over 10% midday and I considered closing all of my trades just to take the profits. Now some of those great positions are eroding, just a bit, but it adds up.
So, I cut a loser Friday. Now I have to decide how much room to give my winners and I find this harder to do than picking an entry point. Entries are easy now... I have a selection of stocks and options to choose from and most of them seem to cycle enough that I do not have to drop any for others now, especially with the options trading allowing me to spend less per trade. The options take a bit more figuring for the opportune entry price but once it's on it's on.
Now my plan is to develop some sort of exit strategy based on rigid rules so I do not have to wallow in the "sell now or hold" limbo land. I should have set this up already, I know, but I got caught up in the buying frenzy.
Seeing as I only have one small loser now, it seems more important to determine how much leeway I need to allow for the winners to run.
Actually, having said that, August is a typically a seasonal peak so I have tightened up my stops to allow me to exit pretty much everything in the green at least... some have some decent profits even at the stops so I cannot complain. I am considering percentage target exits with ratcheted stops given certain price targets.
My long straddle is interesting but not going anywhere quickly. The put is appreciating and the call is depreciating. I started by being down about 25 cents between the two now I am even on the put and down 25 cents on the call. Until the CAH price starts to move I am not likely to see the varied non-linear effect kick in...perhaps once it gets $1 away.
Jeff.
I keep scouring the internet for new information or even a twist on something old...which is most of what is happening anyway.
I was reading an article that re-hashed the same thing that everyone says and everyone thinks it is their idea. I suppose even I am prone to this as here I am writing about it. The difference is this is more a blog than any information providing service.
Three trading "secrets"
1) make a plan and stick to it
2) cut your losers short
3) let your winners run
WHEW! now I know all there is to know about being successful in trading.
Now, I've only been at this for ...close to a two years now and those were probably the first "Rules of Trading" that I ran across. They do make perfect sense.
This is a timely bit of self talk for me today as my positions are doing quite well, nothing too huge, just quite well. My trades are all between -1.6% and +30% on paper right now and the overall average is 8.5%. Not bad for a couple of weeks playing.
Where the timing comes in here is that I was over 10% midday and I considered closing all of my trades just to take the profits. Now some of those great positions are eroding, just a bit, but it adds up.
So, I cut a loser Friday. Now I have to decide how much room to give my winners and I find this harder to do than picking an entry point. Entries are easy now... I have a selection of stocks and options to choose from and most of them seem to cycle enough that I do not have to drop any for others now, especially with the options trading allowing me to spend less per trade. The options take a bit more figuring for the opportune entry price but once it's on it's on.
Now my plan is to develop some sort of exit strategy based on rigid rules so I do not have to wallow in the "sell now or hold" limbo land. I should have set this up already, I know, but I got caught up in the buying frenzy.
Seeing as I only have one small loser now, it seems more important to determine how much leeway I need to allow for the winners to run.
Actually, having said that, August is a typically a seasonal peak so I have tightened up my stops to allow me to exit pretty much everything in the green at least... some have some decent profits even at the stops so I cannot complain. I am considering percentage target exits with ratcheted stops given certain price targets.
My long straddle is interesting but not going anywhere quickly. The put is appreciating and the call is depreciating. I started by being down about 25 cents between the two now I am even on the put and down 25 cents on the call. Until the CAH price starts to move I am not likely to see the varied non-linear effect kick in...perhaps once it gets $1 away.
Jeff.
Friday, August 21, 2009
Long straddle and more options
There are two versions of the straddle, which I found while looking up the real definition of the long straddle. The Strap and the Strip. They are a bullish and bearish twist to the same strategy and I considered one for my CAH straddle trade.
The strap is just weighting the trade toward the bullish side by buying more calls than puts, any ratio will do depending upon how sure I might be of a certain move, this still limits the downside loss should the trade go south but increases the profits if the stock price heads up. Even at this it is still not as profitable as just being right and buying the call or put.
The strip is just the reverse.
Actually, I see there is also a short straddle. This one expects the price to NOT move as I would sell short the calls and puts. Unlike the long straddle the loss is not limited. Should the price move either direction and the option expires ITM then the option will get exercised at my expense. I could always just buy back the options to cut losses though. I have not really investigated this one much at all as I cannot write options right now and I am so stuck on looking for stocks that move that I would be at a loss to try to find stocks that will not move.
Jeff.
The strap is just weighting the trade toward the bullish side by buying more calls than puts, any ratio will do depending upon how sure I might be of a certain move, this still limits the downside loss should the trade go south but increases the profits if the stock price heads up. Even at this it is still not as profitable as just being right and buying the call or put.
The strip is just the reverse.
Actually, I see there is also a short straddle. This one expects the price to NOT move as I would sell short the calls and puts. Unlike the long straddle the loss is not limited. Should the price move either direction and the option expires ITM then the option will get exercised at my expense. I could always just buy back the options to cut losses though. I have not really investigated this one much at all as I cannot write options right now and I am so stuck on looking for stocks that move that I would be at a loss to try to find stocks that will not move.
Jeff.
CAH and the Long Straddle
Well, I couldn't help myself...I had to get one of these in play.
Now CAH may not have been my first choice had I enough time to really do some research but it fits the criteria close enough that I shouldn't lose my shirt on the endeavour.
Here is the chart for CAH, I tacked on the indicators that may be of value in checking these out.
RSI, on top. Any value over 70 is sort of an over bought indicator...just by it's nature as relative strength for this stock has not been above 70 in six months...let alone spent any time above 70.
ATR, bottom is the Average True range over the last five days. It is over 1. This only indicates that the stock's price may move, on average, over $1 per day in the last five days. Unlike the RSI indicator this one does spend some appreciable amount of time over $1 leading me consider that a few $1 plus days COULD be in any direction.
Now CAH may not have been my first choice had I enough time to really do some research but it fits the criteria close enough that I shouldn't lose my shirt on the endeavour.
Here is the chart for CAH, I tacked on the indicators that may be of value in checking these out.
RSI, on top. Any value over 70 is sort of an over bought indicator...just by it's nature as relative strength for this stock has not been above 70 in six months...let alone spent any time above 70.
ATR, bottom is the Average True range over the last five days. It is over 1. This only indicates that the stock's price may move, on average, over $1 per day in the last five days. Unlike the RSI indicator this one does spend some appreciable amount of time over $1 leading me consider that a few $1 plus days COULD be in any direction.
According to my P&F charting this stock would be shortable (buy puts) at anything over $35... so I use $35.50 as the trigger. I figured, rather than just buying a put I would try the straddle and see how it works out...see if my theory matches reality.
I bought the Jan 35 call and Jan 35 put at the same time. Unfortunately both are sitting 10 cents down as I did not get great prices with my limit orders. Ideally, once I decided on a straddle I should set limit orders in the AM and adjust them over the course of the day to get a lower put and option price as the stock price does it's normal gyrations. The 20 cent spread may become negligible over the long run anyway.
Total capital invested $535. I would have preferred to also have the stock price closer to the strike price of both options, CAH was 60 cents ITM for the call which makes it 60 cents OTM for the put. I will place a stop order at half of the value now for each option. This will get me out of the trade for a $250 or so loss, worst case should the price do nothing but hover, which I doubt, or it gets me out of the losing option while the winner runs increasing my profits on that side of the trade.
While I took the time to write this my call is now even (10 cent gain from open) and the put is still at -10 cents. The stock price has only gone up 9 cents or so. This shows the appreciation of the call as the price may be expected to rise, implied volatility at work here increasing the value of the extrinsic portion of the option...one more factor in creating the price movement non-linearity.
Lets see where this takes me.
Jeff.
Thursday, August 20, 2009
Options strategy #1, the Long Straddle
The long straddle, I didn't know this was what it was called though.
For some time I have kept the idea of holding a long and short position simultaneously in order to hedge and take the eventual move, perhaps using some sort of calculated stop. Holding long and short positions in the same account is not allowed...but I have three accounts so I could do it. I eventually figured that there would be no real advantage and I would probably get whipsawed out of both positions for losses anyway.
Then I considered using ETFs. Always long positions but using bull and bear ETFs. I even tried this in a fake account by purchasing $100,000 of ETFs using a balancing method to ensure that the opposing trades were even based on dollar values. What I expected to see was a zero sum game. What I ended up with was an eroded account as the nature of the ETFs lost money in the end.
All in all I was better off just trading long or short and leaving the hedge alone...
...until now.
While playing with the options numbers I came up with a two trade strategy that should produce consistent returns. Like any strategy it relies on certain factors to work out in my favour, it's just that these variables seem easier to determine in advance of the trade and direction of the eventual move is not important.
Noting that the farther In The Money an option gets the closer the correlation of the option price move gets to the stock price move. The converse is also true, the farther Out of The Money it gets the less the correlation holds. Up is still up and down is still down but the ratio shifts to lessen the option price move compared to the stock price move OTM.
So, the strategy is this:
Buy At The Money calls and At The Money puts at the same time for the same stock with a long term expiry. When the price goes up the call option price goes up faster than the put option price goes down. The reverse also holds true. Both options benefit from an increase in volatility as well, but I am not sure how much of a factor this may be.
Stocks to use:
Stocks that are poised to move, say something that has a huge run up that may either continue or pullback. Perhaps something just prior to earnings announcements or big news events which may produce a large swing. There are tons of indicators that could be used to find these, and I tuned a scan to find two or three stocks that fit based solely on charts so the selection is small... intentionally so. No sense in having too many to choose from.
Things to watch for:
Buying the options right will help but may end up leaving me stuck with one side of the trade, the losing side, so limit orders may not be the best idea here. Market orders get me in but then the spread is already a loss.
Finding a stock with a large enough ATR (Average True Range) to ensure that the limits will both get hit or that the small loss is not a large factor would be good.
The last, and perhaps most important thing is to be reasonably certain that the stock is going to move within the timeframe of the option expiry. A stock that tends to languish for long periods of time is not one to choose.
I would consider that a setup that is likely to go in a particular direction already may be a good candidate as at least it will move, then concentrate on the position most likely to prosper first filling in the reverse position afterwards. Buy the call as the price is low and the put as the price is high is the best as this will take advantage of reducing the cost of the spread.
Advantages:
As long as the stock moves one option will out perform the other. I would consider this strategy an add on to existing trading. Something to play with and, if it proves consistently profitable, something to leave in the stable of trade strategies. Perhaps a nice slow account grower to use sideline cash in due to the lower risk associated with it.
An example I pulled from the first chart on my scan results:
CA...I didn't even check the company name, it doesn't matter anyway.
Using the February 22.50 calls and puts (the price is at $22.63 so it is close to the strike, another possibly good factor to consider)
Call option bid = $2.10, buy 5 contracts for $1050
Put option bid = $2.00, buy 5 contracts for $1000
Total capital = $2050
Assuming that the price rose $2.50 tomorrow to eliminate any time factors:
Call = 3.60, value = $1800 gain of $750
Put = 1.05, value = $525 loss of $475
Total value = $2325 for a net gain of $275... a 13.4% return on investment.
Obviously the gain by itself was a better profit as long as it was a correct call.
Assume the price dropped by the same $2.50.
Call = 1.05, value = $525 loss of $525
Put = 3.40, value = $1700 gain of $700
Total value = $2225 for a net gain of $175... a 8.5% return on investment.
Volume is a factor here as the more contracts purchased the greater the actual dollar amount gained. The downside may be the spread loss as it could be 10 to 15 cents per call which could suck $50 - $75 off of each side of the trade with 5 contracts. Spread is a large factor.
This will be tested next week...perhaps I can place a long straddle tomorrow to take advantage of some weekend volatility...we'll see tomorrow.
Jeff.
For some time I have kept the idea of holding a long and short position simultaneously in order to hedge and take the eventual move, perhaps using some sort of calculated stop. Holding long and short positions in the same account is not allowed...but I have three accounts so I could do it. I eventually figured that there would be no real advantage and I would probably get whipsawed out of both positions for losses anyway.
Then I considered using ETFs. Always long positions but using bull and bear ETFs. I even tried this in a fake account by purchasing $100,000 of ETFs using a balancing method to ensure that the opposing trades were even based on dollar values. What I expected to see was a zero sum game. What I ended up with was an eroded account as the nature of the ETFs lost money in the end.
All in all I was better off just trading long or short and leaving the hedge alone...
...until now.
While playing with the options numbers I came up with a two trade strategy that should produce consistent returns. Like any strategy it relies on certain factors to work out in my favour, it's just that these variables seem easier to determine in advance of the trade and direction of the eventual move is not important.
Noting that the farther In The Money an option gets the closer the correlation of the option price move gets to the stock price move. The converse is also true, the farther Out of The Money it gets the less the correlation holds. Up is still up and down is still down but the ratio shifts to lessen the option price move compared to the stock price move OTM.
So, the strategy is this:
Buy At The Money calls and At The Money puts at the same time for the same stock with a long term expiry. When the price goes up the call option price goes up faster than the put option price goes down. The reverse also holds true. Both options benefit from an increase in volatility as well, but I am not sure how much of a factor this may be.
Stocks to use:
Stocks that are poised to move, say something that has a huge run up that may either continue or pullback. Perhaps something just prior to earnings announcements or big news events which may produce a large swing. There are tons of indicators that could be used to find these, and I tuned a scan to find two or three stocks that fit based solely on charts so the selection is small... intentionally so. No sense in having too many to choose from.
Things to watch for:
Buying the options right will help but may end up leaving me stuck with one side of the trade, the losing side, so limit orders may not be the best idea here. Market orders get me in but then the spread is already a loss.
Finding a stock with a large enough ATR (Average True Range) to ensure that the limits will both get hit or that the small loss is not a large factor would be good.
The last, and perhaps most important thing is to be reasonably certain that the stock is going to move within the timeframe of the option expiry. A stock that tends to languish for long periods of time is not one to choose.
I would consider that a setup that is likely to go in a particular direction already may be a good candidate as at least it will move, then concentrate on the position most likely to prosper first filling in the reverse position afterwards. Buy the call as the price is low and the put as the price is high is the best as this will take advantage of reducing the cost of the spread.
Advantages:
As long as the stock moves one option will out perform the other. I would consider this strategy an add on to existing trading. Something to play with and, if it proves consistently profitable, something to leave in the stable of trade strategies. Perhaps a nice slow account grower to use sideline cash in due to the lower risk associated with it.
An example I pulled from the first chart on my scan results:
CA...I didn't even check the company name, it doesn't matter anyway.
Using the February 22.50 calls and puts (the price is at $22.63 so it is close to the strike, another possibly good factor to consider)
Call option bid = $2.10, buy 5 contracts for $1050
Put option bid = $2.00, buy 5 contracts for $1000
Total capital = $2050
Assuming that the price rose $2.50 tomorrow to eliminate any time factors:
Call = 3.60, value = $1800 gain of $750
Put = 1.05, value = $525 loss of $475
Total value = $2325 for a net gain of $275... a 13.4% return on investment.
Obviously the gain by itself was a better profit as long as it was a correct call.
Assume the price dropped by the same $2.50.
Call = 1.05, value = $525 loss of $525
Put = 3.40, value = $1700 gain of $700
Total value = $2225 for a net gain of $175... a 8.5% return on investment.
Volume is a factor here as the more contracts purchased the greater the actual dollar amount gained. The downside may be the spread loss as it could be 10 to 15 cents per call which could suck $50 - $75 off of each side of the trade with 5 contracts. Spread is a large factor.
This will be tested next week...perhaps I can place a long straddle tomorrow to take advantage of some weekend volatility...we'll see tomorrow.
Jeff.
Increasing the signal to noise ratio
Something that I sort of alluded to in a previous post was the slowing down of the trading process when trading options as compared to stocks.
I think that, while this prep time is a little longer and the trade order entry is also a bit longer, the overall signal to noise ratio is increased making up for the other slight downsides. My spreadsheets make the whole selection and order determination a whole lot easier and quicker so that certainly helps.
But back to S/N.
I see my stock positions moving up and down and the P/L moves along with them...penny by penny which translates into 50 cent increments with my 50 share position sizing right now.
Then I see my options positions moving along in 10 cent increments. As the delta on these is 0.75 or higher (all deep ITM long term so far), the option positions, being representative of 100 shares, they tend to move in unison with the smaller stock position but in $10 increments. All those penny moves in the underlying stock have no immediate direct bearing on the current trading price of the option so they get softened. This means that they don't even need to be watched, not that they really did anyway but seeing the minute chart clicking along is interesting, seeing the option price not move for an hour is not so interesting.
This puts me in mind of the P&F charting with it's $1 increments and no time factor. The price can fluctuate wildly within the one point range and the chart never changes. This is a nice easy on the nerves charting and trading plan that I am fitting myself into.
P&F charts and options combine to reduce the need to micro manage positions, even though I am monitoring things rather closely right now I plan on being able to step away from trading and setting fairly wide safety stops for hours at a time...or days down the road when I want to take some extra time.
Some of the next plans, once I get the standard put and call buying down, is to start looking at other strategies including selling covered and naked options and applying stock, option and multi-option combos to capture certain profit targets often.
Sidenote. I have cancelled my real time charting service as it is no longer necessary. As I have numerous positions in play the only ones that get tinkered with that need real time are the new orders...and even that is not really needed. My broker has live feed, on a small scale of four charts, two option chains and two quote screens and that seems to be all that is necessary now. Lower overhead so I can easily offset the additional commissions placed on options in my mind.
My positions are looking good today. I think I am up a couple hundred dollars or more. I'll check later and perhaps setup my performance tracking on the blog homepage now that I am using a strategy and plan regularly.
Jeff.
I think that, while this prep time is a little longer and the trade order entry is also a bit longer, the overall signal to noise ratio is increased making up for the other slight downsides. My spreadsheets make the whole selection and order determination a whole lot easier and quicker so that certainly helps.
But back to S/N.
I see my stock positions moving up and down and the P/L moves along with them...penny by penny which translates into 50 cent increments with my 50 share position sizing right now.
Then I see my options positions moving along in 10 cent increments. As the delta on these is 0.75 or higher (all deep ITM long term so far), the option positions, being representative of 100 shares, they tend to move in unison with the smaller stock position but in $10 increments. All those penny moves in the underlying stock have no immediate direct bearing on the current trading price of the option so they get softened. This means that they don't even need to be watched, not that they really did anyway but seeing the minute chart clicking along is interesting, seeing the option price not move for an hour is not so interesting.
This puts me in mind of the P&F charting with it's $1 increments and no time factor. The price can fluctuate wildly within the one point range and the chart never changes. This is a nice easy on the nerves charting and trading plan that I am fitting myself into.
P&F charts and options combine to reduce the need to micro manage positions, even though I am monitoring things rather closely right now I plan on being able to step away from trading and setting fairly wide safety stops for hours at a time...or days down the road when I want to take some extra time.
Some of the next plans, once I get the standard put and call buying down, is to start looking at other strategies including selling covered and naked options and applying stock, option and multi-option combos to capture certain profit targets often.
Sidenote. I have cancelled my real time charting service as it is no longer necessary. As I have numerous positions in play the only ones that get tinkered with that need real time are the new orders...and even that is not really needed. My broker has live feed, on a small scale of four charts, two option chains and two quote screens and that seems to be all that is necessary now. Lower overhead so I can easily offset the additional commissions placed on options in my mind.
My positions are looking good today. I think I am up a couple hundred dollars or more. I'll check later and perhaps setup my performance tracking on the blog homepage now that I am using a strategy and plan regularly.
Jeff.
ATM options
My first thought after labelling this post was that I might be talking about options trading at your bank machine....right.
I was doing some thinking about my ITM long term expiry option trades last night and decided to look at ATM or At The Money options.
In the money options have a high delta which means the value of the option moves close to the value of the stock, partly due to the intrinsic value appreciating at the same rate as the stock price. So the long term ITM options seem to be a good buy as they will, most likely, always be worth something and the delta increases as they get farther into the money, increasing the symmetry of price movement.
ATM option prices move down around the 0.5 delta range so they move about half...give or take as I have not looked at too many yet as this is just a new idea forming. The advantage is that the option is cheaper as there is no intrinsic value so I would not be paying for any ITM value and could buy more contracts. This is also the downside as the extrinsic value will decay and shift due to time, volatility and price movement against the trade. Ultimately I think that buying enough contracts to offset the variance in delta would probably produce a similar risk so it only allows me to effectively trade options cheaper rather than with more leverage.
Any trade is made with the idea that the stock price will move into a profit position, otherwise why trade at all? Keeping this one tenet firmly in mind there would be no reason to have to pick ITM options over ATM options. I do a fair amount of testing with no expectation of profit, so those trades do not follow this idea, but that is just me.
Using IPI as an example I noted the options data for the Jan calls ranging from strike of $20 up to $30. The stock closed yesterday at $25.40 (a nice even $1 per share for me in one day BTW) which puts the price in the middle of the strike range.
From strike of $20 to strike of $30 the IV drops from $5.40 to zero while the EV starts at $1.30, raises to $3.40 (ATM) and back down to $1.90. The ITM option that I bought was strike $20 so I bought about $4.40 of IV.
The risk with options is restricted to the entire purchase price of the options contracts. With ITM options the risk is larger in this respect due to the IV. ATM options, being that they are pure EV premium means that the risk can be lower as long as the expiry is long term, six months or better. In the last three months to expiry the EV gets eaten up quickly and will reduce to zero as the option expires with no IV. The plan is not to hold them into this last phase anyway.
One of the other "Greeks" used in options is Theta. This represents the erosion of EV based on time decay alone. In the IPI example the Theta ranges from 0.011 to 0.014. My understanding of this number is that it represents the expected loss of EV per day of the option...so the options ranging from $20-$30 strike have very little difference between them. That being the case there is little sense in considering time decay between strike prices a problem this far from expiry.
So, if EV erosion is the same or similar for the range 5 strikes either side of neutral and an ATM option is purchased and the price moves in my favour then the IV increases penny for penny, the EV goes down to result in a net of about a 50 cent option move for every dollar of stock move (real rough).
Other things happen here as well...the EV erosion lessens the farther ITM the option goes increasing the correlation of option price to stock price moves. The farther Out of The Money the option goes the lower the delta and therefore the non-linear relationship effectively slows down the loss rate. This works the same for ITM options so no surprise, it's just that the mechanism is slightly different. Should the implied volatility jump so will the EV. This I have not studied too slosely yet though so I am not sure the relationship.
I was doing some thinking about my ITM long term expiry option trades last night and decided to look at ATM or At The Money options.
In the money options have a high delta which means the value of the option moves close to the value of the stock, partly due to the intrinsic value appreciating at the same rate as the stock price. So the long term ITM options seem to be a good buy as they will, most likely, always be worth something and the delta increases as they get farther into the money, increasing the symmetry of price movement.
ATM option prices move down around the 0.5 delta range so they move about half...give or take as I have not looked at too many yet as this is just a new idea forming. The advantage is that the option is cheaper as there is no intrinsic value so I would not be paying for any ITM value and could buy more contracts. This is also the downside as the extrinsic value will decay and shift due to time, volatility and price movement against the trade. Ultimately I think that buying enough contracts to offset the variance in delta would probably produce a similar risk so it only allows me to effectively trade options cheaper rather than with more leverage.
Any trade is made with the idea that the stock price will move into a profit position, otherwise why trade at all? Keeping this one tenet firmly in mind there would be no reason to have to pick ITM options over ATM options. I do a fair amount of testing with no expectation of profit, so those trades do not follow this idea, but that is just me.
Using IPI as an example I noted the options data for the Jan calls ranging from strike of $20 up to $30. The stock closed yesterday at $25.40 (a nice even $1 per share for me in one day BTW) which puts the price in the middle of the strike range.
From strike of $20 to strike of $30 the IV drops from $5.40 to zero while the EV starts at $1.30, raises to $3.40 (ATM) and back down to $1.90. The ITM option that I bought was strike $20 so I bought about $4.40 of IV.
The risk with options is restricted to the entire purchase price of the options contracts. With ITM options the risk is larger in this respect due to the IV. ATM options, being that they are pure EV premium means that the risk can be lower as long as the expiry is long term, six months or better. In the last three months to expiry the EV gets eaten up quickly and will reduce to zero as the option expires with no IV. The plan is not to hold them into this last phase anyway.
One of the other "Greeks" used in options is Theta. This represents the erosion of EV based on time decay alone. In the IPI example the Theta ranges from 0.011 to 0.014. My understanding of this number is that it represents the expected loss of EV per day of the option...so the options ranging from $20-$30 strike have very little difference between them. That being the case there is little sense in considering time decay between strike prices a problem this far from expiry.
So, if EV erosion is the same or similar for the range 5 strikes either side of neutral and an ATM option is purchased and the price moves in my favour then the IV increases penny for penny, the EV goes down to result in a net of about a 50 cent option move for every dollar of stock move (real rough).
Other things happen here as well...the EV erosion lessens the farther ITM the option goes increasing the correlation of option price to stock price moves. The farther Out of The Money the option goes the lower the delta and therefore the non-linear relationship effectively slows down the loss rate. This works the same for ITM options so no surprise, it's just that the mechanism is slightly different. Should the implied volatility jump so will the EV. This I have not studied too slosely yet though so I am not sure the relationship.
Wednesday, August 19, 2009
IPI and the comparative test
I have a number of option and stock positions in play right now. Overall I am in the green...considering that these are mostly positions taken this week that is not too bad for a three day run in a questionable market.
One test I ran was to enter limit orders this morning for a stock and an option at the same time. I calculated what the option entry price should be based on my trigger price from the stock chart using the various variables for the option and my spreadsheet formulae.
The test subject is Intrepid Potash Inc. (IPI).
The limit orders placed were for $25.50 in the stock and $6.40 for the Jan 20 call option (IFJAT).
Both orders filled quickly off the bell and I might have been able to get slightly better prices for the stock by another 15 cents and 10 cents for the option...but I would probably have sacrificed getting one or the other altogether as the price bottom was hit 3 minutes in. I am satisfied with both entries and happy to see that my estimate of the option price that I calculated from yesterday's EOD numbers was still accurate... and that is the only point for the trade in the first place, profit a close second.
Here is a little chart reflecting some of the numbers for each position.
One test I ran was to enter limit orders this morning for a stock and an option at the same time. I calculated what the option entry price should be based on my trigger price from the stock chart using the various variables for the option and my spreadsheet formulae.
The test subject is Intrepid Potash Inc. (IPI).
The limit orders placed were for $25.50 in the stock and $6.40 for the Jan 20 call option (IFJAT).
Both orders filled quickly off the bell and I might have been able to get slightly better prices for the stock by another 15 cents and 10 cents for the option...but I would probably have sacrificed getting one or the other altogether as the price bottom was hit 3 minutes in. I am satisfied with both entries and happy to see that my estimate of the option price that I calculated from yesterday's EOD numbers was still accurate... and that is the only point for the trade in the first place, profit a close second.
Here is a little chart reflecting some of the numbers for each position.
It is well worth noting that the Extrinsic Value (EV) decreased between 9 and 39 cents (depending on if you use the bid or ask numbers...I would tend toward the bid as that would be the price to sell given a market order...a whole other topic). This drop counterbalances the Intrinsic Value (IV) gain of 69 cents (the increase in stock price) and results in the EOD Delta being lower.
Delta is the expected ratio of stock price movement vs option price movement... initially the 0.823 would mean that if the stock moves $1 then the option price would move 82.3 cents. The IV will always change by the price of the stock, the variable becomes the EX as it is not only a time premium (as it is often referred to) but a volatility expectation premium as well. Higher volatility expectations can yield higher EV values. This is why a flat trading stock that is not expected to move quickly has a very low option EV premium and why some options are very cheap and other can be very expensive even given zero or negative IV.
That's about it for tonight.
Jeff.
Tuesday, August 18, 2009
Options
Well, I think I may be coverting my stock positions to option positions. For now I will run both as I see how the options trades work out. Using options forces me to take a closer look at the pricing and nature of the option, decide on a strike price, expiry date and determine if the option is viable to trade based on the charting that I have been doing. It seems to get me more in tune with the underlying stock as I have to do a LITTLE bit more homework before placing the trade.
All of this slows down my trading, which is a good thing. I am forced to take more time in setting up and reviewing all of the factors that go into deciding to trade or not. This extra time has me looking closer at sector rotation again. While I think that the nature of my stock selection sort of handles this automatically for me I would like to use the rotation strategy more aggressively to make it work as one more factor in pushing the odds into my favour.
The pricing of the options is a factor, obviously. I would trade 100 share lots all the time but find that my capital dissappears quickly, trades entered and not filled still count as buying power used up. Options will run between $5 and $15 for stocks between $15 and $50. Rather than filling up my account with orders this lets me sit in a bit more cash while already having my orders in place. The only possible downside is the inability to buy 1/2 contract sizes, minor problem.
I currently have three option positions, 6 stock positions and a few of each order in place. I think I will let this settle for a bit and see where it all goes now.
Jeff.
All of this slows down my trading, which is a good thing. I am forced to take more time in setting up and reviewing all of the factors that go into deciding to trade or not. This extra time has me looking closer at sector rotation again. While I think that the nature of my stock selection sort of handles this automatically for me I would like to use the rotation strategy more aggressively to make it work as one more factor in pushing the odds into my favour.
The pricing of the options is a factor, obviously. I would trade 100 share lots all the time but find that my capital dissappears quickly, trades entered and not filled still count as buying power used up. Options will run between $5 and $15 for stocks between $15 and $50. Rather than filling up my account with orders this lets me sit in a bit more cash while already having my orders in place. The only possible downside is the inability to buy 1/2 contract sizes, minor problem.
I currently have three option positions, 6 stock positions and a few of each order in place. I think I will let this settle for a bit and see where it all goes now.
Jeff.
Monday, August 17, 2009
Absorbing a loss, visiting the pit of the stomach
No, I am not currently considering a loss on any of my positions. I have stops in place for all but two of them... those two are in the absorption consideration. One is a penny stock and the other is my option trade.
I started trading with a small account, and I still consider that I am using a small account even though it is larger than when I started. I read emails, blogs or accounts of people who are getting jittery over a position that they have that is not moving for them as expected or when expected. If the emotion is strong, then sizing down is in order...or re-thinking whether trading is a good idea in the first place. I have resigned myself to the fact that I could lose every penny of my trading accounts and, while I might miss the money, it will not affect any part of my personal and financial well being.
One of the first things that I threw out the window was expectation. No matter what I expect, the market is going to do what it is going to do and, with very very few exceptions, I will have a negligible affect.
This is where the pit of the stomach comes in.
If I find that I have that nasty feeling in the pit of my stomach then I probably shouldn't be trading that particular trade for a few reasons. Perhaps the size is too big, the possible loss is too big or the trade was placed with a hope or expectation. I have had a few of those trades where I felt terrible watching what was happening and realizing that my money was flowing in the wrong direction.
I am at a point where, while I still care that I may lose money, I know how much the maximum loss will be and I have already accepted that as a fact... "prepare for the worst and hope for the best". I would rather prepare for the worst and plan for the best...otherwise the best may come and go and may be missed altogether.
Jeff.
I started trading with a small account, and I still consider that I am using a small account even though it is larger than when I started. I read emails, blogs or accounts of people who are getting jittery over a position that they have that is not moving for them as expected or when expected. If the emotion is strong, then sizing down is in order...or re-thinking whether trading is a good idea in the first place. I have resigned myself to the fact that I could lose every penny of my trading accounts and, while I might miss the money, it will not affect any part of my personal and financial well being.
One of the first things that I threw out the window was expectation. No matter what I expect, the market is going to do what it is going to do and, with very very few exceptions, I will have a negligible affect.
This is where the pit of the stomach comes in.
If I find that I have that nasty feeling in the pit of my stomach then I probably shouldn't be trading that particular trade for a few reasons. Perhaps the size is too big, the possible loss is too big or the trade was placed with a hope or expectation. I have had a few of those trades where I felt terrible watching what was happening and realizing that my money was flowing in the wrong direction.
I am at a point where, while I still care that I may lose money, I know how much the maximum loss will be and I have already accepted that as a fact... "prepare for the worst and hope for the best". I would rather prepare for the worst and plan for the best...otherwise the best may come and go and may be missed altogether.
Jeff.
Holiday is over, new scaling and options.
Back from my two weeks off. As much as holidays are a nice get away it is nice to be home again. I had lots of time to ponder a great variety of topics and aspects of life....but I will only write about the trading related stuff here.
I gave some more though to my entry strategy, the 25, 25, 25 share scaling and decided it was not the best approach. I ended up sticking on a two trade entry which can be left as a single trade depending on capital and price moves. As a typical trigger may fall on $30 (using 25's I would enter at $30, $29 and $28 with the stop at $27 with an ACB of $29 at 75 shares) I changed my entry sizing to 50 shares and lowered my entry after the trigger.
New entry is 50 shares at $29.50...which is the same as 25 at $30 and 25 at $29 with slightly lower trade costs (minor) while arriving at the same ACB.
The next trade would be another 50 shares at $28.50 which ends up with the same ACB as a full load of 25's, except now it is 100 shares instead of 75. The slight increase in risk is still within my tolerance.
The 25's entry worked well enough while I was away as I placed VTSOs on all of my positions and netted a small profit as they all closed out in the first week. The disappointment was TCO as I only ended up with 25 shares with a $4 and some per share profit... but a profit is not a loss.
Seeing as I am happy with a 50 share trade by itself this makes me feel better about getting only the first trade in. This still let's me trade the slightly higher priced stocks and maybe fill up more often on the lower priced stocks...which leads me back to the topic of options.
There is much not being said about options and exactly how the "greeks" are calculated and what they mean. While there is lots of free information available on stocks there is less on options so I am working on my own knowledge base for these. I have sent off the necessary paperwork to my broker to allow me to trade options in all of my accounts rather than just the one.
Any stock on my hit list over $25 in price has now become an option trade. I have setup a spreadsheet to automatically calculate the option price that corresponds to my P&F trigger price on the stock...this takes into account the various factors relating to how the price can change given the delta, Intrinsic and Extrinsic values. I realize that my estimate will only be close until the stock price actually approaches the initial trigger but close seems to count for more in options than in stocks due to the method used to set quotes (5 and 10 cent graduations).
The reason I decided to go with $25 as the break point for options rather than stocks is not only due to capitalization. Stocks under $25 I have room for quite a few trades and stocks are easier to trade for me right now, quicker trigger calculations, quicker order entry and a comfort level. Previously I had decided to qualify my trade priority based on lower priced stocks first, this allows me to continue trading while studying the option/stock relationship with the larger prices.
I currently have an order in for IPI at $24.50 as well as the Jan 2010 call at strike $20 for $6.40. I am curious to see how the option execution compares to the stock execution.
Upon rethinking the justification for using options for only the higher price stocks I may consider just going to options for all trades. This means I may have to select a few other stocks to base these on as the options chain should have enough liquidity to get in and out smoothly. The advantage to using options for even the lower priced stocks is in the leverage. If a $15 stock have an option that I would trade at, say, $5 then the leverage is an advantage. In addition to leverage this would allow me to enter more trades to keep my diversity up and not have to commit 100% of my cash to active trades...always leaving a bit in reserve for another nice trade setup.
Currently I have one option and four stock positions, one additional option order and three stock orders. I also have a penny stock position and a penny stock order in place. Pennies are something I decided to stay away from in the past but, upon a suggestion I have two trade "dabblings". One thing about pennies, the profit and loss is fun to watch as a 500 share position creates a quick P/L move. 1 cent = a $5 move. I won't mention anything other than my trades here so anyone else's suggestions will remain un-named.
Jeff.
I gave some more though to my entry strategy, the 25, 25, 25 share scaling and decided it was not the best approach. I ended up sticking on a two trade entry which can be left as a single trade depending on capital and price moves. As a typical trigger may fall on $30 (using 25's I would enter at $30, $29 and $28 with the stop at $27 with an ACB of $29 at 75 shares) I changed my entry sizing to 50 shares and lowered my entry after the trigger.
New entry is 50 shares at $29.50...which is the same as 25 at $30 and 25 at $29 with slightly lower trade costs (minor) while arriving at the same ACB.
The next trade would be another 50 shares at $28.50 which ends up with the same ACB as a full load of 25's, except now it is 100 shares instead of 75. The slight increase in risk is still within my tolerance.
The 25's entry worked well enough while I was away as I placed VTSOs on all of my positions and netted a small profit as they all closed out in the first week. The disappointment was TCO as I only ended up with 25 shares with a $4 and some per share profit... but a profit is not a loss.
Seeing as I am happy with a 50 share trade by itself this makes me feel better about getting only the first trade in. This still let's me trade the slightly higher priced stocks and maybe fill up more often on the lower priced stocks...which leads me back to the topic of options.
There is much not being said about options and exactly how the "greeks" are calculated and what they mean. While there is lots of free information available on stocks there is less on options so I am working on my own knowledge base for these. I have sent off the necessary paperwork to my broker to allow me to trade options in all of my accounts rather than just the one.
Any stock on my hit list over $25 in price has now become an option trade. I have setup a spreadsheet to automatically calculate the option price that corresponds to my P&F trigger price on the stock...this takes into account the various factors relating to how the price can change given the delta, Intrinsic and Extrinsic values. I realize that my estimate will only be close until the stock price actually approaches the initial trigger but close seems to count for more in options than in stocks due to the method used to set quotes (5 and 10 cent graduations).
The reason I decided to go with $25 as the break point for options rather than stocks is not only due to capitalization. Stocks under $25 I have room for quite a few trades and stocks are easier to trade for me right now, quicker trigger calculations, quicker order entry and a comfort level. Previously I had decided to qualify my trade priority based on lower priced stocks first, this allows me to continue trading while studying the option/stock relationship with the larger prices.
I currently have an order in for IPI at $24.50 as well as the Jan 2010 call at strike $20 for $6.40. I am curious to see how the option execution compares to the stock execution.
Upon rethinking the justification for using options for only the higher price stocks I may consider just going to options for all trades. This means I may have to select a few other stocks to base these on as the options chain should have enough liquidity to get in and out smoothly. The advantage to using options for even the lower priced stocks is in the leverage. If a $15 stock have an option that I would trade at, say, $5 then the leverage is an advantage. In addition to leverage this would allow me to enter more trades to keep my diversity up and not have to commit 100% of my cash to active trades...always leaving a bit in reserve for another nice trade setup.
Currently I have one option and four stock positions, one additional option order and three stock orders. I also have a penny stock position and a penny stock order in place. Pennies are something I decided to stay away from in the past but, upon a suggestion I have two trade "dabblings". One thing about pennies, the profit and loss is fun to watch as a 500 share position creates a quick P/L move. 1 cent = a $5 move. I won't mention anything other than my trades here so anyone else's suggestions will remain un-named.
Jeff.
Monday, August 3, 2009
Holidays
As I prepare for leaving on a bit of a vacation I thought I would drop into my trading account and set up some VTSOs and close any active buy orders. I am reasonably pleased with my portfolio thus far as there is lots of green even in the stop ranges, profit is stopped out is a good thing.
I have long positions in MS, ABX, IPI, TCO, CVA and AEO. My shorts are MWW and GNK...although GNK is likely stopped out already at a loss. I'll start tracking my performance on the home page of my blog once I get more positions that are based on my final plan and stock selections closed.
I started looking at the "greeks" of options last night while working on something else. The new one is the THETA which indicates how many cents per day the extrinsic value decays based on the current numbers. I also noted that the extrinsic value, which is commonly called the time value, is in now way tied only to the time decay. It has as much to do with volatility as some of the options that I have been looking at have had the extrinsic value change in the opposite direction than I would expect after a few days passed. higher volatility has a higher expectation of price moves which can make the option more valuable to traders which basically raises the premium they are willing to pay for them. Interesting stuff and one more reason to watch for options with a small extrinsic value.
I tried placing an option order after setting my accounts up for options trading and the order was rejected...I guess I need to fill out some more paperwork to activate options in the registered accounts. I'll mail this today so that I can activate my options level first of next week and be able to trade options upon my return in mid August.
This summer is disappearing rather quickly considering that we, here in the Ottawa area, have not really had many days that we could call "summer".
Jeff.
I have long positions in MS, ABX, IPI, TCO, CVA and AEO. My shorts are MWW and GNK...although GNK is likely stopped out already at a loss. I'll start tracking my performance on the home page of my blog once I get more positions that are based on my final plan and stock selections closed.
I started looking at the "greeks" of options last night while working on something else. The new one is the THETA which indicates how many cents per day the extrinsic value decays based on the current numbers. I also noted that the extrinsic value, which is commonly called the time value, is in now way tied only to the time decay. It has as much to do with volatility as some of the options that I have been looking at have had the extrinsic value change in the opposite direction than I would expect after a few days passed. higher volatility has a higher expectation of price moves which can make the option more valuable to traders which basically raises the premium they are willing to pay for them. Interesting stuff and one more reason to watch for options with a small extrinsic value.
I tried placing an option order after setting my accounts up for options trading and the order was rejected...I guess I need to fill out some more paperwork to activate options in the registered accounts. I'll mail this today so that I can activate my options level first of next week and be able to trade options upon my return in mid August.
This summer is disappearing rather quickly considering that we, here in the Ottawa area, have not really had many days that we could call "summer".
Jeff.
Saturday, August 1, 2009
Options, Options, Options....
I have started looking deeper into options to see what kind of strategy might suit me the best. In the process I have found out more about them than I already knew and this has changed the way I think about trading options.
I am looking at trading call options and put options instead of, or in conjunction with stocks, nothing fancy.
The basic tenets of options are that a call gives the owner the option to buy the stock at the strike price within the time frame of the option. The presumption is that the price will be higher at some point before the expiry date so the option is worth more to trade OR the stock option can be exercised to buy the stock at the lower price than current market. A put gives the owner the option of selling the stock at the strike price in the hope that the price will be lower.
The interesting part is that the trading price of the option is made up of two parts with a correlation factor to the stock price itself.
Intrinsic value, Extrinsic value and Delta
Before that, a single option contract controls 100 shares of the underlying stock so the following example, and any options quote, represents one share value...multiple by 100 to get the actual value of the trade. A $4 options contract will be $400 even if the underlying stock is at $23. This makes it easier to trade options with less capital.
Intrinsic value is the difference between the strike price of the option and the trading price of the stock. If the strike price is $20 and the stock is trading at $23 then the intrinsic value is $3 and it is considered to be In The Money (ITM).
Extrinsic value is the premium that factors in the potential value of the option going forward as well as the time value until expiry. The value that traders are willing to pay in the hopes that the stock price will move in favour of the intrinsic value increasing at a greater rate than the extrinsic value decreases. As time progresses the extrinsic value decreases, although time is not the only factor, and the closer to expiry the faster this extrinsic value erodes. The rule of thumb is that the extrinsic value decreases the fastest in the final three months before expiry.
The $20 strike priced option with the stock at $23 might have an extrinsic value of $1 so the option trades at $4. Even if the price does not move on the stock, holding the intrinsic value at $3 the extrinsic value will drop to zero near expiry thereby losing the owner $1.
Delta is the relationship between the option's intrinsic value an the stock price activity. The number is from 0 to 1. A Delta of 0.5 would indicate that, at the current price, if the stock moves $1 the intrinsic value would move 50 cents. A higher Delta is better for my purposes. I cannot see the moving relationship easily but given the different delta numbers at different strike prices the farther in the money the option is the higher the delta is, up to 1. A higher delta gives a higher stock price to option price correlation which comes closer to being able to use options in place of stocks directly.
It is interesting to note that, as I pointed out, the farther in the money the option is the higher the Delta is. This means that the reverse applies, as the stock price gets closer to the strike price the Delta gets lower. This should mean that losing money on an option trade is progressively slower than being in the same stock directly. An option that may be $15 ITM might have a Delta of 0.9. As the option strike prices are closer to the actual price of the stock they reduce, in one case 0.1 for every $5 down to about 0.5, once the option is out of the money the Delta keeps getting lower. So the option still has some intrinsic value left.
An example, Morgan Stanley (MS) call option expiring in January 2010.
Buying an option with a strike price of $17.50 yields a Delta of 0.93, single contract is $11.40.
Compare buying the stock at $28.56, $2856.00 or the option at $1140.00.
The intrinsic value is 11.06 (stock traded last at $28.56), the extrinsic value is 34 cents. If the stock price moves up $1 the option will move up 93 cents and will be $1 farther into the money. The farther into the money the option goes the higher the Delta, which makes the rate of option value increase non-linearly...on the flipside the rate of decrease, should the price drop, will also decrease in a similar non-linear fashion. This will make the downside easier to take and mean that the potential loss on the option is actually lower than the potential loss on the stock itself as a full $10 stock price drop is a full $10 loss on a stock position but the option will not lose the same $10. There will be value left even if the option is at the money.
I do not have the math to show this definitively but the theory is sound and, worst case, the option has the possibility of losing the same as trading the stock...no real downside.
The current $28 strike option is at $3.72 and is only 56 cents ITM.
Intrinsic value is 56 cents, extrinsic is $3.16 Delta is 0.62.
I presume that such a low extrinsic value may be attributed to the sentiment that the stock is likely to drop before January, if the prospects look good for the stock going forward I would expect that the extrinsic value might be higher...but this is just a guess.
That is just some of the basics glossed over. The real point is that there are, in my thinking, two types of options that can be traded, other than calls and puts. I consider a high leveraged option and a low leveraged option.
The high leverage includes any options that have a very high extrinsic value compared to the extrinsic value even though they are priced extremely low. a $1 option looks like a great deal but the extrinsic value may be 90 cents. This means that, if the price does not move in favour 90% of the trade will be lost at expiration. An option, with a higher intrinsic value like the example, leaves only 25% to be lost at expiration. The key is going to be to buy options that are far away enough from their respective expiry dates that eroding extrinsic value is not really a problem AND that the stock price is likely to move in favour of the trade in the short term...relatively speaking.
An expiry at least 6 months in the future with a trade timeline of two months or less would probably be ideal. A higher intrinsic value than extrinsic would also be good and an underlying stock that is in a good high probability setup for a favorable move just adds to the mix.
So here I mix P&F charting with options trading and I have setup a quick spreadsheet that breaks down the option price into it's two values, compares these to the stock price and gives the option price that should correspond to the trigger price on the stock chart. This saves paying for data link for charting option pricing.
All this to avoid having to be restricted to short selling in my small margin account. I will replace short selling with put options and can trade these in my registered accounts.
Oh, there is an advantage to buying puts instead of short selling as well. A short sell has an unlimited loss potential, in theory, and a stop loss is not a 100% guarantee that the price will not gap up way over the stop...I see lots of cases where this has happened on stocks that I have been trading, most were in my favour. At least with a put the loss is restricted to the cost of the options only, and there still may be some value left in the option at that, if it is saleable afterwards.
Options, here I come. More reading to do and some trial to see how the trading is executed though, spreads are larger than I like so I may have to do some searching but I like doing the research.
Jeff.
I am looking at trading call options and put options instead of, or in conjunction with stocks, nothing fancy.
The basic tenets of options are that a call gives the owner the option to buy the stock at the strike price within the time frame of the option. The presumption is that the price will be higher at some point before the expiry date so the option is worth more to trade OR the stock option can be exercised to buy the stock at the lower price than current market. A put gives the owner the option of selling the stock at the strike price in the hope that the price will be lower.
The interesting part is that the trading price of the option is made up of two parts with a correlation factor to the stock price itself.
Intrinsic value, Extrinsic value and Delta
Before that, a single option contract controls 100 shares of the underlying stock so the following example, and any options quote, represents one share value...multiple by 100 to get the actual value of the trade. A $4 options contract will be $400 even if the underlying stock is at $23. This makes it easier to trade options with less capital.
Intrinsic value is the difference between the strike price of the option and the trading price of the stock. If the strike price is $20 and the stock is trading at $23 then the intrinsic value is $3 and it is considered to be In The Money (ITM).
Extrinsic value is the premium that factors in the potential value of the option going forward as well as the time value until expiry. The value that traders are willing to pay in the hopes that the stock price will move in favour of the intrinsic value increasing at a greater rate than the extrinsic value decreases. As time progresses the extrinsic value decreases, although time is not the only factor, and the closer to expiry the faster this extrinsic value erodes. The rule of thumb is that the extrinsic value decreases the fastest in the final three months before expiry.
The $20 strike priced option with the stock at $23 might have an extrinsic value of $1 so the option trades at $4. Even if the price does not move on the stock, holding the intrinsic value at $3 the extrinsic value will drop to zero near expiry thereby losing the owner $1.
Delta is the relationship between the option's intrinsic value an the stock price activity. The number is from 0 to 1. A Delta of 0.5 would indicate that, at the current price, if the stock moves $1 the intrinsic value would move 50 cents. A higher Delta is better for my purposes. I cannot see the moving relationship easily but given the different delta numbers at different strike prices the farther in the money the option is the higher the delta is, up to 1. A higher delta gives a higher stock price to option price correlation which comes closer to being able to use options in place of stocks directly.
It is interesting to note that, as I pointed out, the farther in the money the option is the higher the Delta is. This means that the reverse applies, as the stock price gets closer to the strike price the Delta gets lower. This should mean that losing money on an option trade is progressively slower than being in the same stock directly. An option that may be $15 ITM might have a Delta of 0.9. As the option strike prices are closer to the actual price of the stock they reduce, in one case 0.1 for every $5 down to about 0.5, once the option is out of the money the Delta keeps getting lower. So the option still has some intrinsic value left.
An example, Morgan Stanley (MS) call option expiring in January 2010.
Buying an option with a strike price of $17.50 yields a Delta of 0.93, single contract is $11.40.
Compare buying the stock at $28.56, $2856.00 or the option at $1140.00.
The intrinsic value is 11.06 (stock traded last at $28.56), the extrinsic value is 34 cents. If the stock price moves up $1 the option will move up 93 cents and will be $1 farther into the money. The farther into the money the option goes the higher the Delta, which makes the rate of option value increase non-linearly...on the flipside the rate of decrease, should the price drop, will also decrease in a similar non-linear fashion. This will make the downside easier to take and mean that the potential loss on the option is actually lower than the potential loss on the stock itself as a full $10 stock price drop is a full $10 loss on a stock position but the option will not lose the same $10. There will be value left even if the option is at the money.
I do not have the math to show this definitively but the theory is sound and, worst case, the option has the possibility of losing the same as trading the stock...no real downside.
The current $28 strike option is at $3.72 and is only 56 cents ITM.
Intrinsic value is 56 cents, extrinsic is $3.16 Delta is 0.62.
I presume that such a low extrinsic value may be attributed to the sentiment that the stock is likely to drop before January, if the prospects look good for the stock going forward I would expect that the extrinsic value might be higher...but this is just a guess.
That is just some of the basics glossed over. The real point is that there are, in my thinking, two types of options that can be traded, other than calls and puts. I consider a high leveraged option and a low leveraged option.
The high leverage includes any options that have a very high extrinsic value compared to the extrinsic value even though they are priced extremely low. a $1 option looks like a great deal but the extrinsic value may be 90 cents. This means that, if the price does not move in favour 90% of the trade will be lost at expiration. An option, with a higher intrinsic value like the example, leaves only 25% to be lost at expiration. The key is going to be to buy options that are far away enough from their respective expiry dates that eroding extrinsic value is not really a problem AND that the stock price is likely to move in favour of the trade in the short term...relatively speaking.
An expiry at least 6 months in the future with a trade timeline of two months or less would probably be ideal. A higher intrinsic value than extrinsic would also be good and an underlying stock that is in a good high probability setup for a favorable move just adds to the mix.
So here I mix P&F charting with options trading and I have setup a quick spreadsheet that breaks down the option price into it's two values, compares these to the stock price and gives the option price that should correspond to the trigger price on the stock chart. This saves paying for data link for charting option pricing.
All this to avoid having to be restricted to short selling in my small margin account. I will replace short selling with put options and can trade these in my registered accounts.
Oh, there is an advantage to buying puts instead of short selling as well. A short sell has an unlimited loss potential, in theory, and a stop loss is not a 100% guarantee that the price will not gap up way over the stop...I see lots of cases where this has happened on stocks that I have been trading, most were in my favour. At least with a put the loss is restricted to the cost of the options only, and there still may be some value left in the option at that, if it is saleable afterwards.
Options, here I come. More reading to do and some trial to see how the trading is executed though, spreads are larger than I like so I may have to do some searching but I like doing the research.
Jeff.
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