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.
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