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T – We picked up T when it was trapped in a bit of a range between 36 and 37. We picked it up at a $.38 debit, and it has since gained 15.8% on basically no movement. Suggested Action: None. USO – USO has jumped almost a full dollar since the March put was sold, and has eaten into some of the profits. This was to be expected somewhat, remember this is a longer term plan. Including the profits that are locked in, you are up 38% on this trade. Suggested Action: None. JNUG – JNUG has moved against us over the past couple of weeks, and currently sits at $.57. That is a decline of 4% of the capital required for this trade. This is a trade over the next couple of months, so hold on to it. Suggested Move: None. TLT – Hadik let his TLT trade expire and took small gains, however even Hadik believes TLT will still maintain upward pressure, as does many of the other analysts that I follow like Jake and Elliott Wave. This was a short-term trade, however, so I’m inclined to sell it off at a small loss. Suggested Move: Sell at $1.95 debit (2.2% loss)
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In all cases, SLM, GM, CELG, and NBIX, we are holding our sold puts, even though all but NBIX are below their strike values. We want to own these stocks, and we may by March expiration. There was only one piece of fundamental news. CELG received an refuse to file (RTF) from the FDA on their prized pipeline drug, ozanimod, designed to treat MS. Dave stated that this will likely set the launch of this drug back approximately a year, but because the RTF wasn’t issued for a safety reason, it will not hurt chances for approval that much. That being said, my personal feelings are that this points to management issues. From a large biotech company, this is usually avoided by constant communication with the FDA and thorough disclosure in the filings. While the CELG fundamental case changes very little, I am put on alert, and I think management needs to prove themselves a little bit here. I would still own CELG at these levels, but am put more on alert. So far, we discussed all the essential option characteristics. What an option is, its variables, and how to use options for risk adjustment. So now that you know these things, there are several “goto” strategies that take advantage of the flexibility of options. These are general strategies, and not specific to a trade. When you become a “master builder”, you can use these as a template and use your knowledge of options to alter them slightly to match your expectations.
I will separate them into long-term and short-term strategies. The cutoff for these would be 30 days. That’s when theta kicks in pretty heavily and price changes become predominant instead of volatility, so that’s a good metric. This isn’t to say you shouldn’t use these strategies on either side of that 30-day border, but these strategies typically have a long term or short term focus. Long-Term Options Strategies Buying Naked Options – This is when you just purchase a call or a put. It is the simplest, and probably first option trade you do. More than likely, you lost money on that first trade because you didn’t understand the options fully. I say this is a long term-strategy because if just buying a naked call or put is your strategy, theta will burn you really fast. You may hear people trade “lotto calls”, and they work when they outpace the theta decay. If anyone knows when that will happen, it is a good technical trader. But the most lucrative options trades these traders execute are the trades that originate more than 30 days out. This is because traders see the overall trend, and it is easier for the stock price to outpace theta. Characteristics: Delta positive for calls (negative for puts), theta negative, vega positive, possible return is infinite, possible loss is option price. Selling Naked Options – Traditionally these are considered long-term strategies. I know many options strategists that sell 5-10 delta SPY puts 20-40 days out every day and make 6-10% per month. For the past 7 years it worked beautifully, making them almost triple digits per year. Without a plan, however, corrections will slaughter your portfolio, making all those portfolio gains worthless (if you are curious, they hedge with long VIX calls to cut into their profits by ~25%). In the end, this is a very effective strategy if you have the margin but is also very dangerous if you have no experience. These are prominent in my fundamental newsletter since the premium attached to the options account for more than the opportunity cost of holding that cash in an interest bearing account. Characteristics: Delta negative for calls (positive for puts), theta positive, vega negative, possible return is premium, possible loss is infinite. Cash-Secured Put – I put this under "selling naked options" because it is basically the same thing for puts, but I wanted to describe the strategy separately. If you do not own a security but are sitting on a pile of cash waiting for a security to get cheap enough to buy, you may sell puts in the security at the price you plan on buying at. For example, let’s say you don’t own BMY at $60, but are willing to buy BMY at $55, you can sell a Mar $55 put for $60 per option. For 10 options, that’s $600, 1% gain on that money in a month. Sure beats today’s savings account rates. This is a strategy for the disciplined value investor, who doesn’t try to time the market but understands the company he/she is buying and knows when it is a good value. Characteristics: Delta positive, vega negative, theta positive, trades premium for willingness to buy stock at a certain price. Covered Calls – This is a fantastic plus-up trade for the disciplined long-term value investor. Let’s say you are bullish on BMY and own 1000 shares. BMY currently trades at around $60, and you are going to sell it at $65. You can put in a "good until cancelled" sell order at $65, pocket your 8% no matter how long it takes (including never), and move along. Let’s say it takes a year. That’s a nice return! During that time, however, you can sell 10 $65 calls 30 days out. Right now, that returns about $39 per option. Sell 10 of them, and you made $390 automatically. If the price goes up to $67 at expiration, you have basically sold your options at $65 and made that extra $390 on top of it. If it took 12 months, you made an additional $4680 to the 8% you made above (assuming the stock steadily goes to $65). That’s 7.8%, you doubled your income. Furthermore, you will still make that money if the stock goes down. And that is on a low-IV stock. This strategy is met with mixed feelings in the option world. I like it for the “disciplined value-investor”, because the disciplined trader will sell at $65 and not worry that it went to $67. He/she won’t feel like they lost. If you treat the $65 mark as a “target”, then you might not like the covered call, because as soon as it hits $65 you now have a naked sold call in your portfolio until it goes back to $65 or expires. There is also a question of dividends. Do I owe or receive dividends if I own an option, and the answer is no. But the option pricing will reflect the change in underlying’s price. The only danger with dividends is if the strike price is close to or below the underlying price in the covered call strategy, the receiver of the option may assign on ex-dividend date. Other than that, there’s no change from dividends. Characteristics: Delta negative, vega negative, theta positive, trades premium for capping gains from owned securities. Short-Term Strategies Vertical or Spread – I had a hard time deciding where to put this strategy because it could be long or short term. A vertical is selling a call or put, and leveraging it with a higher or lower call or put price on the same expiration date. One interesting thing about a vertical is that it doesn’t matter whether you use calls or puts, if the short strike is higher than the long strike, it is bullish. Opposite is bearish. You may hear the term “debit spread” or “credit spread”. A credit spread is one where you collect money for the execution. Essentially if you use puts for a bullish spread or calls for a bearish spread, it is a credit spread. The returns only change if the premium is different between credit and debit spreads. For example, a Mar BMY 50/55 put credit spread will yield 9% on your margin, while a Mar 50/55 call debit spread will yield about 8%. There’s no difference between the two, so you do the credit spread! Usually i trade the options that are OTM because they have higher volume. Now if you are perceptive, you may be thinking “Wait, why would I ever do a cash-secured put if I could do a vertical?” If you are strictly an options trader, you are absolutely correct. The amount of margin required for the above cash-secured put is $5500, while the margin required for the 50/55 vertical is roughly $460. You can exponentially increase your returns. However if your short options get assigned, you will be responsible for paying that full amount for the shares. So you don’t necessarily want to increase your spreads by 10 to use the same amount of margin… you can wake up to a surprise bunch of shares the next morning, especially since you can’t exercise YOUR puts before you get a margin call. The most you could lose, however, is the difference between the short and long strikes minus the premium which is why so little margin is needed. Also, because verticals are vega negative, they are a much better play for earnings or catalysts. Do not purchase straight calls or puts for catalysts. Characteristics: Vega negative, theta positive, max gain is premium (for credit spreads), max loss is difference between long and short strikes minus the premium. Max gain is premium. Straddle – Straddles are buying calls and puts at the same strike on the same expiration. This strategy tries to take advantage of short term volatility, but when you have two sets of theta negative trades and diametrically opposed prices that must make up for each other, the price better be really volatile for you to make money on this strategy. Typically this strategy is used as insurance against expected movements, but it is probably the worst way to play any sort of earnings or catalyst. Needless to say, I will very rarely suggest this strategy. You have to have a good idea of how much the market will move before you execute this one, and rarely do I have that kind of insight. Characteristics: Delta neutral, vega positive, theta negative, max loss premium. Max gain is infinite. Iron Condor – An iron condor is basically a bearish and bullish vertical facing each other from different strikes, creating kind of a table in the risk chart. Typically they bracket the underlying price and are a delta neutral strategy. You want the price to not move, as theta works its magic. Another attractive thing about this strategy is that you collect two premiums (bullish and bearish sides) for the same spreads, making the margin even lower. Iron condors are typically only done with 2 credit spreads, so when exercised, it looks like you are “selling” a condor. However, you can “buy” a condor and reverse all of its metrics making a straddle, but I don’t advise it. This is the first in a class of strategies called “Income Trading”, as there are traders who sell a condor and have specific plans two adjust at certain points in the trade to keep theta working. Those adjustments come at a price though, so the goal is to have enough premium to make adjustments and still make money. The following trades are all income trades, but could be used for speculation as well. Characteristics: Delta neutral, vega negative, theta positive, max loss is different between one side’s long and short strike minus total premium. Max gain is premium. Butterfly – This is like an iron condor, except both short strikes are at the same strike price. Typically a butterfly is in the same option class (all calls or all puts). If it involves both options classes, it is called an Iron Butterfly. Those are my favorite trades because you have a lot of premium to work with, and margin required is typically low. Characteristics: Delta neutral, vega negative, theta positive, max loss is different between one side’s long and short strike minus total premium. Max gain is premium. Calendar – If you look back in article 3, you will see that theta is exponentially decreasing the closer you get to expiration. This strategy tries to take advantage of that by selling an option at a certain strike, and leveraging that with an option with a later expiration date (typically a month later). You will also note that IV is higher in out months, because there are more likely to be larger shifts in price the more time you have. Because of that, this is an important strategy because it is a theta and vega positive trade. Because there is more time premium in further out trades, this is always a debit trade. If it is ever a credit trade (except on VIX), I’m sure a computer somewhere would find it before you do, buy it, and exercise both immediately and pocket the nickels. Expiration for the strategy is considered to be the front month. A lot of times you may hear me refer to something called a "campaign calendar". This is when I execute a calendar that is out of the money where the front month is within 30 days and the back month is several months out. If the underlying does not move how I expect because I feel it needs more time, I will wait for the front month to expire, and just sell the next monthly option. So the full scope of the trade plan may take a while, and every front month sold decreases the total capital in the trade. The way you can lose money in this trade is as the underlying price goes further away from the strike price, the extrinsic value goes down much quicker than the theta decay. So the goal is to have the trade migrate closer to the strike price. Characteristics: Delta neutral, vega positive, theta positive, max loss is premium paid (unless held after expiration). Max gain cannot be measured concretely. Diagonal and Double Diagonal – This is basically a directional calendar. The difference is that the front month is sold at a different strike price. It is speculative like the vertical, but vega positive. The double diagonal is essentially an iron condor, but the long strikes have later expiration dates. Characteristics: Delta neutral, vega positive, theta positive, max loss is premium paid (unless held after expiration). Max gain cannot be measured concretely. |
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November 2024
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