DITM LEAP Calls or Near Month DITM Call, which one is better?

Discussion in 'Options' started by tangpd, Apr 4, 2011.

  1. tangpd

    tangpd

    Hi, this is my first post and I hope to get some advise from seasoned options traders.

    I have been doing Covered Calls for a while using DITM LEAPS as a synthetic replacement of the stock. This is a strategy that was proposed as a cheaper way than to buy stock, though of course I will have highly leverage (more gain, more pain) and I forfeit any dividend payout. So I have been doing this on mainly commodities ETFs which of course have no dividend payout (GLD, SLV, USO etc..)

    Lately these ETFs have weekly options, so instead of selling a front-month OTM call once, I can do this 4 times a month. Then I started to notice that 1-2 months DITM calls may be a better buy than the LEAPS as they need less money down and I am not paying so much more for the extrinsic time value. To give an example:

    Case 1: Buy 10 JAN12 115 GLD (291 days to expiry)
    10 JAN12 115 GLD at $26.50, at today's GLD at $139.2

    Option Time Premium paid = 26.50 - (139.2-115) = $2.30.
    Total Time Premium paid = $2.30 X 10 X 100 = $2,300.
    Per day time decay (theta) = $2300 / 291 days = -$7.90
    Total Delta = 0.87 X 10 X 100 = 870 pts.
    Total outlay = $26.50 X 10 X 100 = $26,500.

    Case 2: Buy 10 MAY11 113 GLD (46 days to expiry)
    MAY11 113 GLD at $26.45, GLD price at $139.2

    Option Time Premium paid = 26.45 - (139.2-113) = $0.25
    Total Time Premium paid = $0.25 X 10 X 100 = $250
    Per day time decay (theta) = $250 / 46 days = -$5.43
    Total Delta = 0.99 X 10 X 100 = 990 pts.
    Total outlay = $26.45 X 10 X 100 = $26,450.


    Now for both cases, I then sell 10 APR211 141 Call (4 days to expiry) at 0.41, theta is 0.385

    Since CC makes money by selling OTM calls and hoping that it expires worthless, for my synthetic CC, I need to ensure that my theta is highly positive even after I have purchased a DITM call (which gives me a negative theta), it would seem to me that buying a nearer DITM Call will give me a bang for my buck.

    Case 1: Buy 10 JAN12 115 GLD and sell 10 APR211 141 Call
    JAN12 115 GLD theta = -$7.90
    APR211 141 GLD theta = (0.385 X 10 X 100) / 4 = $96.25
    Total Theta = $96.25 - $7.90 = $88.35

    Case 2: Buy 10 MAY11 113 GLD and sell 10 APR211 141 Call
    10 MAY11 113 GLD theta = -$5.43
    APR211 141 GLD theta = (0.385 X 10 X 100) / 4 = $96.25
    Total Theta = $96.25 - $5.43 = $90.82

    Also I will make more $$ from any increase in GLD for the MAY11 113 Call compared to the JAN12 115 Call due to the bigger delta.

    Of course if GLD drops, I lose more in case 2, but I can always roll-out to a further month, unless of course GLD crashes under 113 and stays there indefinitely (a scenario which I think is highly unlikely given QE2, QE3 etc.. from uncle Ben). I will also not be too affected by volatility swings for near month DITM Calls.

    So I cannot understand why I should not be purchasing nearer DITM Calls than LEAPS for my CC.. other than danger of black swan event and price crash. Your comments are highly appreciated. Sorry for such as long posting.

    Thanks!
     
  2. good710

    good710

    Thank you, for answering. But this method works for me only with .. In all other cases I get only strange results, like those below :lol:
     
  3. More later, time permitting...
     
  4. It seems like your biggest worry is the relative theta and delta risks of the nearer vs longer term ITM calls. Why don't you just sell the put while buying the call--eliminate the decay and normalize the delta of your (now) synthetic position to 100?

    Your biggest problem here will be liquidity. Paying someone else' market in a 90 delta leap won't be cheap.