|
There seems to be a lot of chatter and momentum in the options space about binary options. A binary option is different in that it has two outcomes, max gain or max loss… hence the name, "binary option". So unlike a regular option, these options do not have infinite gains nor variable gains based on how much higher the underlying is above the strike price at expiration. The gain can either be an asset or cash, and these options are bought or sold for a premium.
Basically, these options are like a sports bet. Let’s say you put $10 down on a 50/50 chance for a team to win. If you are right, you get paid back $9, if you lose, you lose $10. Because of this, it is foolish to buy binary options if you are paying a premium since the payout is a 50/50 chance. In fact, in many countries, binary options are considered a form of gambling and are illegal. Many binary option brokerages have turned out to be scams, so when it comes to binary option trading, do not even bother. However, one thing that binary options do offer is a great way to evaluate pricing models and option pricing. From an option pricing point of view, a binary option kind of acts like a vertical at the same strike, making for much easier calculation of return to risk. It also is shown to be a great tool to measure the efficiency of the return of a vertical, since the middle ground of a vertical is the non-binary part of the calculation and tends to get in the way of the OCD option trader’s return to risk calculation. Therefore, a 1 wide vertical in most underlying vehicles can synthetically represent a binary vertical. I highly recommend that, since the return-to-risk is higher in that strategy than any other vertical spread as shown by binary options. In short, binary options are the academic option student’s delight, but from a practical standpoint, they are a scam.
0 Comments
If you have watched my webinar series, I warned against going naked calls. Most of the time, brokers do not let you sell calls naked. This weekend, a group called OptionSellers.com went bankrupt for selling calls naked on UNG, or natural gas. Here is their letter to investors:  It doesn’t matter why natural gas shot up 10% in 3 days; it happened, and OptionSellers.com should have had a risk management plan.
Being that a major portion of my personal strategy is premium selling, here are some things I am doing differently that would prevent such a catastrophe: 1. NEVER go naked short calls. I would always make short positions into verticals. 2. Delta hedge. You may not make as much money, but it is a major tool in taking drastic moves out of the equation in these positions. 3. Given the above, I will always pay attention to the return to risk. This can be done primarily using the Sharpe Ratio, measuring discounted investment returns over the standard deviation of the probability of its success. But it doesn’t work when the risk is “infinite”. 4. I will manage your portfolio risk responsibly as laid out in our ADV 2A, including not using margin. I guarantee that you would NEVER be found in a debit. Risk management is paramount to my trading strategy, as it should be yours. I cannot guarantee I won’t lose money, but you will not be left in financial ruin like this hedge fund has left their clients. New information coming out of the MTF is suggesting that the current trade we have on is not ideal for the new track. Therefore, we are going to adjust and reconstruct the trade a bit to a balanced butterfly.
All in November, we have an 80/82/83 butterfly, 7 spreads. Make it into a 79/81/83 butterfly. So: buy 14 $82 calls, sell 14 $81 calls... then sell the $80 calls, and buy 7 $79 calls. This creates $20 of slippage in profitability, but aligns the thesis better. We have held this $SPX trade since March, and it is the most successful trade in this newsletter's short history. In fact, it has wielded not only a considerable percentage from the trade itself, but there have been tranches that have added to the equity return.
Today, I am closing it out. I sold the SPX vertical at $10.45, a 221.5% return on this original trade not including the tranches and hedges that were done along the way. Here's why: Avi is talking about a drop to 2830 being a pivotal moment. DaybyDay has a drop to 2790 in the near future. Hadik has a drop to 2800. Further, there are questions among the trusted analysts about this bull market being over, with a multi-month top being put in place. There may be a chance we will see a leg higher, but the long term portion of the equities trade is over. I may play some shorter term equities trades in the future, while I wait for confirmation that the long term bear market trade has begun. I have closed the XLU trade at $.18 debit. This was a very low maintenance, high probability trade. XLU has a very high Variance Risk Premium, so these kinds of trades are perfect for this vehicle.
With $SMH, I am officially making a slight expansive adjustment. I am going to be buying back half of the bullish verticals for $112.50. It is a profit on those legs, but allows for more downside. This was part of the newsletter plan.
After being exercised in some of my $RSX September Puts, I decided to do a little bit of a different trade. Buy back your 21Sep puts in RSX, then sell 100 19Oct $20 strike, and buy 50 19Oct $18 strike puts.
If you put this one on, you may need some help to prevent any kind of margin errors. Please direct message me on Twitter. This is due to a thesis change. $GS trade, meant to capture a large 3rd wave up in November, is showing the chances of weakening. Sell half of the position at $.56 credit for a 19% gain. This is strictly a technical play; reload when $GS reaches $229.
Newsletter alert: Sold $GD fly at $4.27. This was bought at 3.75, a 13.9% gain.
With such high gamma (since we are close to expiration), I will sell it sometime today (August 14, 2018) instead of rolling the dice between a massive gain or massive loss tomorrow. Could have made more after earnings, but I won't complain about a profit. Thanks, Zac Mannes! As my vacation wound down, I was greeted with a couple of concerning news items.
One of the tariffs levied upon the US was on semiconductors, which had a direct effect on our SMH trade. As a reminder, the SMH trade was a 102/107/112 put butterfly expiring this week. Thursday close was at 108.14, so there was some room to drop. However, the news caused a gap down to 106.44, causing the IV to spike, liquidity to drop, and our returns to start feeling some heat. I always tell option traders to wait for the market makers to catch up to any gaps before trading, usually at around 10-10:30am unless it is an emergency. Because we weren't very far from our short strike, I didn't consider it an emergency. In fact, the trade was a little green on the day. However, because of the news I was expecting volatility to pick up a little bit, which hurts a vega negative position such as a butterfly. Since the news was negative and SMH price was below the short strike (we were delta positive after the gap), I felt the return had a greater chance of shrinking than growing. Finally, since expiration is 1 week away, gamma is relatively a high negative number which would eat into profits further if more downside were to be seen. You can see this in the chart below. The purple is the P&L now, the blue is the P&L at expiration. If we saw a continuation down on Monday, you can see how much profit it would take with it on our position, and how little we had to gain if it spiked up. The position would depend on a bounce, which I wasn't confident in, especially considering EcoQuant's chart signaled more downside.  So even though we did not meet our expected profit of $750, we were within $1.50 of our short strikes, and EcoQuant identified the chance of a small pop before further downside, I decided to close the trade. This is how you trade by the greeks with a technical thesis. |
The WizardJason DeLorenzo Archives
January 2022
Categories |
RSS Feed