Overall strategies - what works for you?

Discussion in 'Options' started by scriabinop23, Jun 27, 2006.

  1. I'm new to this game, and have been studying quite a bit. I started trading options for the first time several months ago. Had a bad experience overleveraging myself buying too much of the wrong direction at the wrong time. (isn't that classic !!!)

    Well, thankfully I didn't gamble the whole portfolio. I lost about 4% of my total portfolio in addition to what I lost in my normal other investments (mutual funds, some international funds, and a basket of stocks that is generally pretty conservative [low beta]).

    The interesting thing is - instead of me deciding to quit options and go back to my old ways, I had an epiphany with the realization that the amount of risk my normal portfolio is in. [i am about 70% invested in conventional stock equity instruments] I think I've lucked out on my stock picking in the last few years, so I've gotten complacent as to the possible downsides (that is, until the internationals popped recently).

    Because of all of this, I've geared down, studied strategies, studied -proper- money management (ie trading option qty's in a way that doesn't cause much drawdown when you do poorly), etc. --- and I've come to a realization: In this higher interest rate period we're entering, I want to get out of equities almost entirely, go to cash/bonds/higher-yield items, and get my excess returns from the options side of my portfolio. This way I can use interest production from the bulk of my portfolio to hopefully offset most option buying costs.

    Now the point of the message - there seems to be quite a few options games out there - but I've conceptually reduced them to two classes (1: sell, 2: buy):

    1) making money off volatility changes and theta decay (usually involves selling options at high IV, and rebuying at low). Also - speculating on market direction (or lack of) and hoping for little standard deviation of general market prices - ie selling far otm credit bull put spreads & far otm credit bear call spreads. LARGE risk in those infrequent months of wildness. Most strategies, like butterflies, condors, etc. are really adaptations and altered manifestations of this simple concept.

    2) simplest, but lowest risk: buying puts, calls, debit bullish call spreads (to reduce call purchase prices), and debit bearish put spreads. Simple speculation on market movement -- most money made on swing trading or longer periods. This technique could also serve as a substitute for scalping with underlying, as there is much less principal risk (downside exposure is larger on underlying scalps). on the other hand, unless options are far enough in money, small movements sometimes don't translate into price differences (because theta and market maker bid/ask spreads and nickel/dime quantization). I know McMillan isn't a fan of this, but I'm not convinced YET. Straddle buying resolves directional issue, but theta and IV exposure is doubly magnified as a downside.

    While #1 sounds tempting, one drawdown can easily wipe out 10 or more profitable transactions. I'm not even considering doing #1 unhedged (ie naked call or put selling). So I'm thinking about #2 until I'm otherwise convinced of some excellent risk management strategies to #1.

    The fundamental question: how many of you guys actively manage your entire portfolio like this? Any seasoned professionals think this is a bad idea? Any faults in my thinking? Is it naive to expect I'll do moderately well (better than interest income alone, or better than old fashion unhedged straightforward stock + mutual fund ownership) on #2 strategy alone?

    I'm also considering a hybrid with a small part of the portfolio - instead of all cash in portfolio, perhaps 10 or 15% in high yield quality stocks I can write covered calls against to get my yearly yields up from 5% -> 10%.

    I like the reduced risk - being able to sleep at night when indexes are tumbling a few percent a day - like they did in May/June, and might continue to.
  2. The yield curve is already inverted. It might become more exaggerated after Thursday.

    Also, one minor point. Writing naked puts is not nearly as dangerous as naked calls. It has the same risk as covered calls, and is slightly less risky than naked stock.

    (Sorry I didn't anwer your main question. I'm wrestling with the same issues myself.)
  3. true - but realistically, stocks move by std deviation - not up 1000%, down 50% (although I'm sure it has happened). so if you have a neg. movement 20 points, you likely don't really want to be stuck with the stock you sold naked puts on - there's probably a reason. we agree though - both are pretty risky, and the downsides can spell wipeout pretty quickly, if any amount of leverage is used.
  4. i never hold my long options longer than 30days before expiration

    In my opinion the value starts decreasing a lot, 3-4 weeks and upwards before expiration.

    just like to buy puts and calls (and sell em afterwards :) )

    keeping it simple

  5. pattersb

    pattersb Guest

  6. so you buy mostly 60-90 days out, or longer?
  7. Very interesting post, I've read it a couple of times and you are asking the question we all ask ourselves.

    One comment on your choice of #2 however is that straight put/call and debt spreads, while defined risk are generally directional where if you are wrong you lose 100% of your bet. Is this not what you started out doing?

    Personally I have begun to favor #1. When I started out last year I did mostly #2 and won some lost some. Since I've been doing more credit spreads, calendar's and other high probability trades I'm actually winning at a higher rate. You can also often adjust or roll out of a trade to give the market more time to go in the direction you have forecast. The beauty of credit spreads and volatility plays is that you can be partially right or wrong and still make money. The problem with a debt spread or straight put or call is too often you decide to cut your loses when holding it may have actually been the better choice.

    When you are trading stocks you make a purely directional bet. With options you make a volatility bet as well as directional bet and it is helpful to know which strategies work best for the type of bet you want to make. This will only come with your personal experience and willingness to try (with very small number of contracts) different strategies in different markets to determine what will work best for you.
  8. toc


    What works for me......playing harmonious music as per the astrology, tunes the mind for good decisions.
  9. Actually, I never (again) write puts on a stock I don't want and can't afford to own. You are still better off than just owning the underlying stock at the price it was when you wrote the contracts.

    I'm trying writing a few Jan 07 LEAPS puts. I know a lot of more advanced people here don't like them. I take the view that I would rather buy, for example, 1000 shares once at a 6 dollar discount, than 1000 shares six times at a one dollar discount.
  10. so you buy mostly 60-90 days out, or longer?

    yes, this seems to work for me. Although i still sometimes miss some swings because i sell too soon, because i'm afraid i'll lose the time value
    the logical thing would be to roll em over to a later expiration. but then i think i'll roll em over on a pullback, or upswing and a lot of the times that never happens and then i dont want to chase it.
    You'll know soon enough :)

    other logical solution would be to buy em 3 months or so untill expiration, but then the money question starts playing.
    #10     Jun 30, 2006