IPI: Short put: Sell Jun 17.25 put for a net credit of $60 Yield = 60/1665 = 3.6% in 105 days or 12.5% annualized Prob = 68% Expectation = .68(60) - .01(404) - .31(202) = 40.8 - 4.04 - 62.6 = -25.84 Move out and make a spread: Sell Sept 17 put and buy Sept 14 put for a net credit of $60 Yield = 60/240 = 25% in 196 days or 47% annualized Prob = 65% Expectation = .65(60) - .10(240) - .25(120) = 39 - 24 - 30 = -15 The spread is less bad than the short put but the MM's are not giving you a positive expectation anywhere. (They're not supposed to..that's how they keep their jobs) Given the chart... http://finance.yahoo.com/q/bc?s=IPI&t=2y&l=off&z=l&q=l&c= You can only expect to win if the running trend is over.... i.e. a reversal of expectation. http://finance.yahoo.com/q/bc?s=IPI&t=5d&l=off&z=l&q=l&c= not a lot of evidence of that.
There are 2 problems with your spread assumptions and presentation: Your probability calculation, your expectation calculation, and your % return calculation are all meaningless. WHY? Because going out through Sept 20th, you are going through 2 earnings cycles. Going through that type of unpredictability "twice", as well as the unpredictability of a potentially volatile market for more than 6 months.... renders all calculations meaningless. In addition, in order to earn that meaningless, but potential 47% return, assumes all your money is 100% invested in spreads or spread type strategies. In other words, you are not sitting with a cash reserve. Therefore, you are on potentially massive amounts of leverage. (Probably 8 - 10 times your account value) Therefore, if your stocks drop even just slightly below your strikes, you can not buy 90% of them. You will be forced to close for a loss. (A 15 - 20% drop and your loss is 100%.) If I were to, "in theory", use a similar amount of ridiculous fantasy leverage selling naked puts, my annualized % return would be considerably higher than your 47%. But I don't trade based on fantasy assumptions. Bottom line..... your assumptions are based on the unpredictability of more than 6 months exposure to the market,.... 2 earnings cycles,.... using massive amounts of fantasy leverage,.... an inability to consider buying 90% of your stock(s) , even if they're just slightly below your $17 strike(s),.... you risk a 100% loss of capital if the stock(s) drop 18% below your $17 strike,.... and most of your calculations are ridiculously "generic", thus having little to do with your actual specific stock.
Put Master is in a bad mood today which makes him more idiotic than usual (if that's possible). The short put and spread calculations are correct and tell an interesting (if re-iterated) tale. The further out spread is a better statistical bet than the shorter naked put. Although NEITHER are very good bets... on a statistical basis. If he could get his mind off his pathologic pre-occupations he would recognize the limitations of his one and only strategy. Lots of ways to string a violin, each with it's own advantages and disadvantages. In this instance the one outstanding truth is that IPI is in a persistent downtrend and initiating a bullish position without solid evidence of a turn around is pretty risky: http://finance.yahoo.com/q/bc?s=IPI&t=2y&l=on&z=l&q=l&c= Which is all the probability and expectation calculations are saying. I suspect that PM had a serious deficit in his education which is what makes him so hostile to statistical proofs. I say the following with all due charity: PM should not be trading real money. He simply is not competent to do so. (plus he's a little crazy)
Sorry to say, but the only thing more meaningless than your 6.5 month "generic" statistical calculations, are your 6.5 month "assumptions", which are based on those meaningless calculations. The only calculation that is real, is the degree of massive leverage use required, to earn that potential 47% annualized return. But all the other 6.5 month statistical probability stuff is just silly.
Edit to add the comment I'm responding to: ***There is no way you are going from 12% in an IRA to 60% in a non IRA using the same stock and strike.... unless you are changing your strategy from selling naked puts, to selling put credit spreads.*** -Put_Master PM, regarding the 60% return I mentioned in the IPI short put trade, it is attainable in a Reg T or Port Mgn account. Prem: $0.60/share or $60/contract Margin per contract: $312 DTE: 106 ROI at expiration: 19.2% ROI PA: 66.2% Granted, these are best case ROIs with the following important assumptions: 1. The underlying doesn't move too strongly toward the strike. 2. The individual does not set aside - in a spreadsheet or in his head - additional margin (a safety cushion) for the life of the contract. 3. At expiration, the individual continuously redeploys capital in similar or better-returning trades. Switching gears, I hear ya' loud and clear about 10% to 18% being a very good return for a tax deferred account. What I'm unsure about is whether ~10-12% is worth the effort in research and trade monitoring, knowing that for each 'unit of capital' I will probably have to do it 3-4 times a year. One option is selling LEAPs, another is to piggyback trades I've made in taxable accounts so the research effort is nil. I'll keep plugging away trying to find the right balance. It used to be easy when preferred stocks and Canadian and US trusts could be counted on for relatively certain high single digit returns. ¡No más!
What does it mean when I post probability levels and expectations associated with trades??? It strikes me that PROBABLY PM is not the only one who does not understand when I post probability and expectation calculations. Let me go though just those two items: Probability: When I say that such a trade has a probability level of say 75% it simply means that the position of the strike involved falls at that level on the probability distribution curve of the stock. http://en.wikipedia.org/wiki/Probability_distribution Multiple studies have shown that stock prices follow a log-normal probability distribution. The probability distribution curve for the stock is simply derived by computing the standard deviation of the stocks prices in the past. It does not mean anything more than that. (how long in the past is another level of discussion... but mostly past time periods are the same as predicted time periods). Expectation: When I say to you that the stock has a 75% probability of finishing the time period of the trade above (or below) a specific strike I am only telling half the story. The rest of the story is in the size of the win and the size of the loss. e.g. if I have a 90% probability of winning the trade, but the amount I win is only $1 while I have a 10% probability of losing on the trade but the loss is $100 clearly this is not a good trade even with the high probability. Statistical expectation takes into account the size of the win, the size of the loss and the probability of each: http://en.wikipedia.org/wiki/Expected_value E[x] = X1P1 + X2P2.....XkPk. This is expectation. PM constantly makes the statement that these are 'meaningless' but they are really far from meaningless. Yes... between now and expiration many events can occur which would be disruptive to the price of the stock... but the past history (on which statistics are based) also has in it earnings reports and market events which are incorporated in past behavior statistics so, to some extent, unless the future is very unlike the past (which it may be) the probability and expectation PROBABLY will be predictive. Of course whatever method you use to guess the future will be based on the past, and what would make us think that calculating has any less reality than how we 'feel' about a stock??? Only the pathologically non-quantitative would think so. All of this is about a single trade and not about portfolio performance which is an entirely different matter.... something PM seems to not understand. Note: all of my calculations are based on cash accounts, margin accounts are infinitely more complex.
My discussion is based on annualized % return at year end. Yours is based on ROI. My discussion is also based on reality, vs theory. Your discussion is based on your theoretical statement that... "at expiration, the individual continuously redeploys capital in similar or better-returning trades." That assumes the stock barely fluctuates all year, as you continuously redeploy capital at expy. It assumes no margin calls all year, even though you are continuously at max margin levels. In reality, you are not going to be able to leverage a naked put much more than 4 times your account value. You have a better chance for success selling credit spreads on excessive leverage, than this strategy.
Just to follow up.... PM, being pathologically non-quantitative, constantly decries my probability and expectation calculation as 'meaningless'.(mostly because they reveal his trades to be bad judgement) If I look at any option table for any stock I see in there option prices for expiration times way into the future. Currently Jan '15 seems to be the limit. Where does PM think the market makers get these option prices? Of course they use the Black-Scholes option pricing models which are based on the probability distribution of stock prices in the past. http://en.wikipedia.org/wiki/Black–Scholes Of course, as I remember PM is (or at least was) ignorant of the Black-Scholes equation which is the basis of all option pricing models.
<<< Switching gears, I hear ya' loud and clear about 10% to 18% being a very good return for a tax deferred account. What I'm unsure about is whether ~10-12% is worth the effort in research and trade monitoring, knowing that for each 'unit of capital' I will probably have to do it 3-4 times a year. One option is selling LEAPs, another is to piggyback trades I've made in taxable accounts so the research effort is nil. >>> Frankly, I do NOT think it's worth the effort and time of research. But given the ridiculously low VIX environment we are in, we are all forced to either adapt to those current market conditions,.... or take additional risks to compensate for the low VIX and premiums. However, doing that will have the affect of lowering the "probability" of the trade being successful. There is really no correct answer. We each have to make our own choices about risk, reward, probability, ect....
<<< When I say that such a trade has a probability level of say 75% it simply means that the position of the strike involved falls at that level on the probability distribution curve of the stock. http://en.wikipedia.org/wiki/Probability_distribution Multiple studies have shown that stock prices follow a log-normal probability distribution. The probability distribution curve for the stock is simply derived by computing the standard deviation of the stocks prices in the past. It does not mean anything more than that. >>> Thank you for your "theoretical" discussion. In other words, you acknowledge it doesn't mean anything, in the "real world" of trading specific stock and strike selection, per unit of time. <<< Where does PM think the market makers get these option prices? >>> Don't you mean to say those FLUCTUATING option prices??? <<< Of course they use the Black-Scholes option pricing models which are based on the probability distribution of stock prices in the past. >>> If you really believe option prices are based solely on the past, you really don't belong in the market trading options. They are based on a BLEND of the past, current and future probability,.... supply and demand,.... interest rates, ect.... Hence the reason they FLUCTUATE. <<< Of course, as I remember PM is (or at least was) ignorant of the Black-Scholes equation which is the basis of all option pricing models. >>> You live in a theoretical fantasy world. Hence your tendency to say silly things.