yes you are right about the risk/reward but with a caveat: The 10/1 is if I would let the stock go all the way to the bottom of the spread. People who do this kind of trading never do that. In addition to picking fundamentally sound stocks to begin with you need to have a keen sense of smell for trouble and be willing to bail at the first indication that your strikes might be violated. I don't have statistics but I would guess that my running R/R is much more positive based on my ability to get out before the crap hits the fan. As for buying the stock it's not the same thing. To make money buying the stock the stock has to go up, Ignoring dividends. If I sell DIM bull put spreads the stock does not need to go up to make a profit. It can even go down a little. Also the raw dollars required to take a position are completely different. Also there are several outs that can be taken if you have the judgment to take them at the right time. e.g. If the underlying takes a dive and passes below your upper strike you can sell the lower put for a profit and allow yourself to be put in anticipation that the stock will recover and you will end up in a winning trade. This is another reason why stock fundamentals are so important to this trading methodology. I have had several instances where the stock takes a dip, I sell the long put and allow myself to be put at the upper strike; I sell calls or not depending; then the stock recovers and makes the compound transaction show a profit. It takes judgment, patience and a fundamentally sound stock to work with. In all of this I am using bull put spreads as the example. All of the same considerations are true for my bear call spreads... but in reverse. e.g. SPLS and CREE. Finally (whew). Yes the probability calculation which is Log Normal based is only a guess at best. I do not use it in anticipation that it is accurate but simply as a quick check on my logic that I am not completely off base. It says that I am or am not in sync with past market pricing. Often I am assuming that the fundamental environment for the stock is in flux and past stock pricing does not at all predict future pricing but that the stock is in transition to a new base, either up or down...in which case the probability calculation is double nonsense. I will probably calculate it anyway.
One more: On a yearly basis I am making about 12% on my invested capital. This includes many trades that make 20+ percent mixed with bailouts and idle money waiting to buy stock if that's required (which I keep in treasuries...and a few high dividend leveraged holdings like ACG).
VNQ: http://stockcharts.com/h-sc/ui?s=vnq http://www.cbsnews.com/news/stock-prices-fall-as-interest-rates-climb/ http://seekingalpha.com/article/2491395-real-estate-shorts-are-in-play http://finance.yahoo.com/news/4-moves-consider-making-fed-141022008.html http://finance.yahoo.com/q/bc?t=2y&s=VNQ&l=off&z=l&q=l&c=&ql=1 Trade: With VNQ at 73.86 Mar 78/80 bear call spread for a net credit of $30 Yield = 30/170 = 17.6% in 197 days or 32.7% annualized Prob = 70% Expectation = .7(30) - .22(170) - .08(85) = 21 - 37.4 - 6.8 = -23.2 Price..........Profit / Loss.........ROM % 55.40..............30.00.............17.60% 63.96..............30.00.............17.60% 72.97..............30.00.............17.60% 78.00..............30.00.............17.60% 78.30................0.00...............0.00% 80.00............(170.00)..........-85.00% 85.00............(170.00)..........-85.00% 90.00............(170.00)..........-85.00%
FRED: http://finance.yahoo.com/news/bear-day-freds-fred-050022641.html http://finance.yahoo.com/news/freds-reports-wider-expected-q2-133002525.html http://finance.yahoo.com/news/freds-down-strong-sell-poor-183002390.html http://finance.yahoo.com/q/ks?s=FRED Key Statistics http://finance.yahoo.com/q/co?s=FRED+Competitors http://investing.money.msn.com/investments/financial-statements?symbol=FRED http://stockcharts.com/h-sc/ui?s=fred http://finance.yahoo.com/q/bc?t=2y&s=FRED&l=off&z=l&q=l&c=&ql=1&c=^GSPC http://finance.yahoo.com/q/bc?s=FRED&t=2y&l=off&z=l&q=l&c= Trade: With Fred at 14.58 Jan 17.50/20 bear call spread for a net credit of $35 Yield = 35/215 = 16.3% in 122 days or 48.7% annualized Prob = 82% Expectation = .82(35) - .063(215) - .12(108) = 28.7 - 13.5 -13.0 = 2.2 Price..........Profit / Loss.......ROM % 10.00.............35.00..............14.00% 13.00.............35.00..............14.00% 16.00.............35.00..............14.00% 17.50.............35.00..............14.00% 17.85...............0.00...............0.00% 19.32..........(146.70)...........-58.68% 20.00..........(215.00)...........-86.00% 22.00..........(215.00)...........-86.00% 25.00..........(215.00)...........-86.00%
http://finance.yahoo.com/q/bc?t=5y&s=SO&l=off&z=l&q=l&c=XLU&ql=1 XLU: Jan 40/35 bull put spread for a net credit of $50 Yield = 50/450 = 11.1% in 120 days or 33.8% annualized Prob = 77% Expectation = .77(50) - .02(450) - .21(225) = 38.5 - 9 - 45 = -15.5 SO: Jan 40/35 bull put spread for a net credit of $33 Yield = 33/467 = 7.1% in 120 days or 21.5% annualized Prob = 85% Expectation = .85(33) - .01(467) - .14(234) = 28.05 - 4.67 - 32.76 = -9.38 same trade
ED: http://finance.yahoo.com/news/consolidated-edison-grows-utility-business-204001979.html http://finance.yahoo.com/news/why-earnings-streak-continue-consolidated-104939727.html http://finance.yahoo.com/q/ks?s=ED Key Statistics http://investing.money.msn.com/investments/financial-statements?symbol=ED http://finance.yahoo.com/q/co?s=ED Competitors http://finance.yahoo.com/q/bc?s=ED&t=2y&l=on&z=l&q=l&c= ED pays 4.5% in dividends Trade: with ED at 56.63 Feb 52.50/50 bull put spread for a net credit of $40 Yield = 40/210 = 19% in 153 days or 45% annualized Prob = 80% Expectation = .8(40) - .08(210) - .12(105) = 32 - 16.8 - 12.6 = 2.6 Price...............Profit / Loss..........ROM % 35.00................(210.00).............-84.00% 45.00................(210.00).............-84.00% 50.00................(210.00).............-84.00% 50.61................(148.70).............-59.48% 52.10.....................0.00.................0.00% 52.50...................40.00................16.00% 55.00...................40.00................16.00% 60.00...................40.00................16.00% 65.00...................40.00................16.00%
WMT: http://finance.yahoo.com/news/walmart-wmt-woes-continue-higher-195502797.html http://www.theday.com/article/20140815/BIZ03/308159971/-1/BIZ http://finance.yahoo.com/q/bc?t=2y&s=WMT&l=off&z=l&q=l&c=&ql=1&c=^GSPC http://finance.yahoo.com/q/bc?s=WMT&t=2y&l=off&z=l&q=l&c= Trade: with WMT at 76.84 Jan 80/82.5 bear call spread for a net credit of $40 Yield = 40/210 = 19% in 117 days or 59% annualized Prob = 74% Expectation = .74(40) - .13(210) - .13(105) = 29.6 - 27.3 - 13.65 = -11 Price..............Profit / Loss..........ROM % 65.00.................40.00................16.00% 70.00.................40.00................16.00% 75.00.................40.00................16.00% 80.00.................40.00................16.00% 80.4...................00.00.................0.00% 82.50..............(210.00).............-84.00% 90.00..............(210.00).............-84.00% 95.00..............(210.00).............-84.00% 100.00............(210.00).............-84.00%
EIX: http://www.zacks.com/stock/news/148591/3-utility-stocks-to-protect-your-portfolio-in-choppy-market http://finance.yahoo.com/q/ks?s=EIX Key Statistics http://investing.money.msn.com/investments/financial-statements?symbol=EIX http://stockcharts.com/h-sc/ui?s=EIX Trade: with EIX at 55.75 April 45/40 bull put spread for a net credit of $25 Yield = 25/475 = 5.26% in 199 days or 9.6% annualized Prob = 95% Expectation = .95(25) - .01(475) - .04(238) = 23.75 - 4.75 - 9.52 = 9.5 Price..........Profit / Loss.......ROM % 30.00..........(475.00)........-95.00% 35.00..........(475.00)........-95.00% 40.00..........(475.00)........-95.00% 44.75...............0.00.............0.00% 45.00..............25.00............5.26% 50.00..............25.00............5.26% 55.00..............25.00............5.26% 60.00..............25.00............5.26%
CNX: http://finance.yahoo.com/news/bear-day-consol-energy-cnx-050025730.html http://finance.yahoo.com/news/consol-energy-reports-second-quarter-103000513.html http://finance.yahoo.com/q/ks?s=CNX Key Statistics http://finance.yahoo.com/q/is?s=CNX http://www.msn.com/en-us/money/stockdetails/financials/fi-126.1.CNX.NYS http://finance.yahoo.com/q/bc?s=CNX&t=2y&l=on&z=l&q=l&c= Trade: APR 45/50 bear call spread for a net credit of $30 Yield = 30/470 = 6.4% in 187 days or 12.5% annualized Prob = 83% Price.............Profit / Loss.........ROM % 28.40..............30.00..................6.00% 34.94..............30.00..................6.00% 41.83..............30.00..................6.00% 45.00..............30.00..................6.00% 45.30................0.00..................0.00% 48.72...........(342.00)..............-68.40% 50.00...........(470.00)..............-94.00% 55.61...........(470.00)..............-94.00% 62.50...........(470.00)..............-94.00%
CPB: http://finance.yahoo.com/news/campbells-initiatives-keep-growth-momentum-153003166.html http://finance.yahoo.com/news/campbell-misses-4q-revenue-forecasts-120856492.html http://finance.yahoo.com/q/ks?s=CPB Key Statistics http://finance.yahoo.com/q/co?s=CPB Competitors http://finance.yahoo.com/q/bc?s=CPB&t=2y&l=off&z=l&q=l&c= http://finance.yahoo.com/q/bc?s=CPB&t=1y&l=off&z=l&q=l&c= Trade With CPB at 42.37 Jan 38/35 bull put spread for a net credit of $21 Yield = 21/279 = 7.5% in 106 days or 26% annualized Prob = 85% Expectation = .85(21) - .03(279) - .12(140) = 15.2 - 8.4 - 16.8 = -10 Price.........Profit / Loss..........ROM % 25.00.........(279.00)..............-93.00% 30.00.........(279.00)..............-93.00% 35.00.........(279.00)..............-93.00% 36.77.........(101.80)..............-33.93% 37.79..............0.00..................0.00% 38.00.............21.00.................7.50% 40.00.............21.00.................7.50% 45.00.............21.00.................7.50% 50.00.............21.00.................7.50%