When we began trading we found it near impossible to find knowledgeable option traders willing to help answer our questions and with a genuine interest in making others better traders. We often refer to trades as being ‘just for fun’ but if we can help answer questions and take each member to a level of trading competence they never dreamed possible than we will feel like we really achieved something special. We received some interesting questions from one of our members, Don, and decided to share the answers in the hope that it might be somewhat helpful to you.
Selling calls against either stock or LEAPS is an easy concept. Here’s what I don’t get…Let’s say we own the AAPL LEAPS at 36.00 and we start to sell the calls against it starting this NOV. I would sell slightly out of the money to receive premium hoping that we don’t get to that higher strike. If we do I see that as trouble since I would then have to use some of my money to buy back the sold call-it seems as if you easily adjust trades either out in time or up in strike (getting a reduced premium) at an additional cost to us…conceivably if a stock continued rising we would be incurring cost while the LEAPS wouldn’t be rising fast enough to keep up with us.”
Another way to view the trade is to break down the cost and the credit separately over time. For example, in 20 days I can generate $4.20. It’s not a big stretch at all to argue that, conservatively, I could get at least $5 over any 30 day time period for entering short options just out of the money on a regular basis. So, after 8 months I pay myself back $40 – more than the cost of the long option! Still, I would have at least half a year before the Jan09 options would expire worthless!
Most people view this negatively because it means the instant gratification of seeing a short call expire no longer exists. But ask yourself this if you ever feel that way – “Do I plan on trading the stock market next month also?” If the answer is yes then how could there possibly be a problem making money with the long call this month with the knowledge that you will make even more money on a short option further out in time than you could have made this month (because a credit was taken in when the original short call was moved to a higher strike further out in time). It’s really all about taking a longer term perspective.
Don: “Pricing the options by including the only variable (IV) and using stock screening systems to figure in the Delta so that I can see the change risk/reward.”
Some option traders think that they should sell the option because it is expensive. But this can be a catastrophic mistake. The option was expensive for a reason! For example, let’s say that you did a scan on options and found that WCG put options were expensive and hence should be sold. You log in to your brokerage account and enter some naked puts. Woohooo, easy money, right?! \ Two days later the stock was down over $80 and those naked puts that were supposed to be easy money have suddenly become VERY expensive! Just an FYI, ThinkorSwim has a tremendous platform with tons of functionality that let’s you play around with an option’s risk variables.
Don: “With stocks like AAPL/GOOG they have had a lot of price movement. Is this the best way to get premium or should I be looking for a stock where the IV is closer to the HV?”
Stock & Option Trades: Finding premium is really easy! All you have to do is look at Cramer to find the growth stock du jour! Ok, just kidding – kind of! Any stock that has huge levels of stock volatility tends to have options with a ton of premium also. Take a look at VMWare as an example. Even after earnings has been announced you can find options worth almost 5% of the value of the stock for November! If you want to do a scan, search for stocks with beta values greater than 2.0 and you should find many of them have high option premiums associated with them.
Don: “Lastly on some of the trades recommended there is a purchase of stock “A” at 50. Then a short put (sold?), long put(purchased?) and short call (sold?) don’t these positions require constant monitoring? For instance on the short call hopefully selling on a bounce, buying back on a dip and are we doing the same thing to the put, why are we doing all three things in addition to the purchase.”
So why add the bull put spread? If we were simply traders we wouldn’t care for bull put spreads. But as investor/traders we seek to find value also. If we place a bull put at a certain point we are picking a level where we believe, even after a pullback, the stock is a value play and we would be happy taking ownership of the stock if the short puts were assigned. If they expire we just made some decent premium anyway. We don’t enter naked puts, however, because disaster could strike at any time (see the WCG example as a reason why we avoid naked puts!).
Your question was don’t these positions require constant monitoring. Unfortunately yes! A few months ago when the trades were simple spreads and directional long positions it was easy to sit back but as volatility picks up and the clouds appear on the horizon we need to baton down the hatches and take action and unfortunately that does mean slightly more sophisticated strategies and work. No way around that unless we want to risk much more capital.
Stock & Option Trades
