Fridayâs Activity: My previous post showed a sale of 6 SU SEP 35/37.5, but I did not have the information at hand to calculate profit. This was originally 3 SU SEPT 70/75 that split 2 for 1. My cost was $4 for the spread, so the split spreads cost $2.0 each and sold for 2.45. Gross profit on yesterdays sale is 600 X .45 = 270. **** I decided to roll my UNG spread, out and down. My expectation is that natural gas will show a seasonal high in winter, but I donât have a feel for the magnitude of the gain. By rolling the spreads I effectively reduced potential profit for a safer position. An OTM position is rolled to an ATM position. SOLD: original position 10 UNG JAN 40/45 @ 1.35, original cost was 3.6. BUY: 10 UNG APR 35/40 @ 2.25. So the new position is: 10 UNG APR @ 4.5, (cost = 3.6 + 2.25 â 1.35 = 4.5) history = -2271. If this works out, I will regain the lost $2271 plus gain a small profit of $500 (gross). So my choice is to consider this a position modification, and will report gains or losses in my running totals at the close of the position. So some may consider this a headfake, it is within my rules stated earlier to do this *****
8/25/08 Activity: SOLD: 4 MLM OCT 750 @ 4.9 NET PROFIT 348.8 SOLD: 5 EGH JAN 110/115 @ 3.15 NET LOSS 309.9 (on low expectations for EEM) BUY: 100 SLV (long) @ 13.22 SOLD: 10 WFT 32.5/35 @ 1.58 NET LOSS 134 (stock @ 38.06, near breakeven, got better uses for the money) BUY: 10 GLD MAR 66/71 @ 3.95 Stock at 81.03, comm. 17.6, EXPECTED GROSS PROFIT 1050. BUY: 5 USO OCT 75/80 @ 4.2 Stock at 92.38, comm. 8.8, expected gross profit 400. (only 1.5 months out, but looks low risk to me) ***** Well as expiration times keep diminishing and prices change constantly, I have to continually re-evaluate positions. Here is another position that I feel I should roll out and down. EWZ is the etf for Brazil and Iâm losing confidence that it can recover in time for a Jan09 expiration. So Iâm rolling it out to Jan10, and down a $5 level. It is a long time to keep a position, but will allow me to recover from a bad position. I think. SOLD: 4 EWZ JAN09 75/80 @ 1.9 (cost was 3.8) BUY: 4 EWZ JAN10 70/75 @ 2.35 New position is 4 EWZ JAN10 @ 4.25 (3.8 â 1.9 + 2.35), history = -769. **** P&L SUMMARY (from 5/12/08 start of journal, previous summary July 11) PROFITABLE TRANSACTIONS: 33 for 12492.35 LOSING TRANSACTIONS : 33 for 11408.93 Total Profits: + 1083.42 **** Portfolio status: previous report July 11) Maximum value of spreads if 100% success = 180022 Present value of spreads = 123232 Amount remaining to be earned = 56790 Average max yield (56790/123232) = 46 % (indicates high risk over 30%. In spite of the high %, most of the spreads are looking pretty safe to me right now, if my expectations are correct.) Max future account value = 224698 (with 100% spreads + no change in GLD or SLV longs) ****
PROPOSITION: There is no reason to (permanently) lose money on a DITM vertical spread position that is no longer DITM due to declining stock price, under the following conditions: CONDITION 1: There is sufficient time value remaining in the spread. CONDITION 2: There is the expectation that at some unspecified future date, the stock value will recover to move a declining spread back DITM CONDITION 3: There are future expiration dates available to work with. That a damaged spread, under these conditions, can always be rolled out to a further expiration date for approximately no cost. Theoretically this can occur for an unlimited time frame. **** DISCUSSION: The purpose of the thread has always been to talk about what I consider an incredible investment strategy, and to figure out how to make it better, safer, more reliable, more immune to mistakes and mis-information, more immune to seasonal fluctuations or earnings reports or market manipulation or management screw-ups. There has been discussion of hedging with puts. It simply does not work within the framework of this strategy. We may forget about the possibility of a silver bullet put strategy to shield DITM vertical call spreads. I have used a tactic in the past with decent odds of success, called rolling a spread. In this tactic, you replace one or both legs of a spread with other options at a different strike price or expiration date. Obviously there are almost unlimited choices how to do this. Other than spread manipulation, the only other decision is to hold or sell the spreads. This is the most used method for risk management. It is the best choice if the expectation for a company is really unknown or gloomy. What is supposed to happen is you sell off losing spreads and hopefully replace them with profitable spreads. There is nothing wrong with this tactic, if fact the tactic to be discussed in the âPropositionâ is a just variance of this tactic. Of course Iâm only talking about DITM spreads, other option strategies have their own adjustment procedures. There is another tactic that is available. I donât recommend or use this tactic because you can lose a lot of money if you guess wrong. The possibility of buying back one or more short calls that have greatly decreased in value (thereby showing a large paper profit) can be done. Now you have a huge shortfall in the long calls that more than offsets your gain from buying back the short calls. You also have lost the âprotectionâ of the short calls that was in the spread. But if the stock recovers before the expiration date you can make a larger profit. Back to the âpropositionâ, let me use an example to make the point. What is the point? The point is that trading/investing is a mental game as well as a financial game. Making the decision to take a loss is one of the hardest things a trader has to do, and is often so emotional that they do it wrong. Too soon â too late â too much â not enough, etc. I also made the point is a recent post that the more you believe in the position, the more you will lose if your are wrong. Well, I mis-stated that. Not only IF you are wrong but WHEN (in the flow of time) you are wrong. The difference between the option guys and the longs is TIME and leverage. What happens to our mental well being when we option guys can have as much time as we want, for free (approximately)? If so, the decision is not how much money to lose, but how long do I have to wait to collect my profits. A much less dramatic decision, donât you think? There is some rationality here, I admit, but there is validity as well. Note: as Iâm writing this the market looks like a blown-up balloon that is suddenly released and flying all over the place. Traders are having fun playing with Gustav. If you look at my trades, you will see I have several times rolled a spread On 6/08 I explained the term âhistoryâ. On 6/10 I went through rolling one leg of a spread. On 8/23 I rolled a spread out and down. Same thing on 8/25 with EWZ. Now let me tell you what I should have done: I should have simply rolled out the spread to a further month using the SAME price strikes. Also, many of the positions I closed out at a loss â like SII, ECA, MDR, TIE, APA, GG, MTW â what I should have done is simply roll them out. It is not a disaster doing what I did, since I did put the money to work, but I think it would have been better to roll out. Take a position I have right now: 10 CNX JAN 65/70 @ 3.7. CNX is jumping all around from 60 to 70. Who knows where it will be in Jan. The spreads right now can be sold for 2.25. This represents a potential loss of $1450. However, I can also buy the APR spreads for 2.3 or the JAN10 spreads for 2.10. If I feel that sometime in the future, CNX will settle down to a price above 70, then I can gain more time for the spreads to work and turn a $1450 loss into a $1300 profit by exhibiting a little patience. And it doesnât cost me anything but time. The figures Iâm quoting are real taking into consideration bid/ask spread. This is also an action I will consider as I watch the price. Mentally speaking, taking a $1450 loss is gut wrenching and traumatic, but when tempered by the prospect of recovering that in the future with a good profit to boot is very appealing. Another thought. This intuitively feels like a smart options play, since the same market forces that are working against you now are working for you in the future.
9/2/08 Activity: BUY: 100 SLV @ 12.60 (long) BUY: 5 DVN APR 75/80 @ 3.45 Stock @ 95.90, comm. 7, expected gross profit = 775 BUY: 5 FCX APR 55/60 @ 3.85 Stock @ 83.03, comm. 7, expected gross profit = 575 BUY: 5 EOG APR 65/70 @ 3.85 Stock @ 96.41, comm. 7, expected gross profit = 575 Journal reference: GLD 79.3, UNG 33.5, USO 89.0. All in, again.
I am a current EE and good luck with your journal... It will take some time for me to understand what you are doing, but that's always true with us tech guys.
so u are pretty much playing a game on premium? for instance, on 5 DVN APR 75/80, you got netted $1.50 on the spread. so 1.50 x 5 = approx. $750. so as long as the stock price stays above 80, and assuming you get out right, u'll net $775? I forgot all these strategies playing dumb equities all day. but in spread plays, u get unlimited potential losses while limited gain right? and in order to reduce the risk u play far off the current stock price. so in the same example above, does the stock price have to be at 80 (at exp) for u to achieve max gain? thx for refreshing series 7 studies.
Yes. the expected gross profit is (5.0-3.45) * 500 shares = 775. You are also correct about limited loss/limited gain. Max loss is 5 spreads X 345 cost per spread = 1725. If the stock is 80.01 or more, I make max profit. Gain = 775/1725 = 44.9%. Thanks for your interest.