Safer option strategies

Discussion in 'Options' started by madbrain, Nov 10, 2011.

  1. madbrain


    I'm looking to get into option trading. I'm familiar with the basics of options. I have made some small trades as far back as the late 1990s. Mostly buying and selling calls. But it's been with fairly small amounts, under $5k. My latest one was buying SPY leaps call in august and selling in october - too early, I might add, but still at about 10% profit.

    I have a much larger portfolio now. About $350k in 401k/Roth IRA which is mostly in equity index funds, and staying there. And over $400k in cash accounts, earning a measly 1% in FDIC insured bank accounts.

    I'm looking for a slightly better return than 1%, but without as much downside risk as holding the equity index funds long-term.
    Bond funds don't look attractive to me due to long-term interest rate risk, and the short ones pay nothing.

    I'm willing to do the work to do what it takes to manage a small risk and get ideally earn 3-7% a year without taking huge risky bets all at once. I'm looking for some safe option strategies. This probably does not fit the profile of most traders here, but I need to state what my goals are ;)

    I'm not looking to trade on margin, as there is no scenario under which I would ever want to lose all or more than my principal. I have brokerage accounts at Fidelity, Schwab, Vanguard and Optionsxpress. None of them are funded right now. I started playing with the virtual trading at, as well as optionsxpress (seems to be the same platform).

    I am looking to trade mainly index ETF options. SPY is the primary one I looked at. I am not interested in trading options on any individual stock, or holding any individual stock.

    I would like to hear mainly from people who trade in cash accounts, not margin.

    I have many questions :

    1) Which broker would you recommend for a cash account ?
    2) When did you move from paper trading to real trading ? How long did you paper trade/backtest ?
    3) How large are each of your individual positions vs the size of your account ?
    4) Which are the safer option strategies that you use ?
    I have looked at selling covered calls. But that requires first buying the underlying, which has large downside risk. Not enormous with the index, but still, it has gone 50% within a year at times (2008). One can also buy a put option to protect against it, but this makes the trade less or not profitable. I want to keep things simple.

    5) The main strategy that I'm looking at is selling a small number of weekly out-of-the-money put contracts on SPY (or another passive ETF with liquid options), with the goal of collecting small premiums, holding to expiration every week, and not getting assigned. The premiums are especially attractive right now with all the volatility. I would just buy one option. I would not buy another put to mitigate the potential loss, as that would reduce the potential return too much. If assigned, I would just hold the SPY shares, and place GTC limit orders to resell them at or slightly above the put strike price. I would hold those (hopefully small) amounts of shares indefinitely until they sell at least at the purchase price, and never realize the loss on the shares. Even if assigned one week, I would repeat the same strategy every week with the remaining cash, regardless of the underlying price.

    Selling cash-covered puts is a bullish strategy. So, I started backtesting it with a spreadsheet against some of the worst bear to see how badly it would fare, with SPY data from 2008. I put in all the weekly lows and highs.

    I was backtesting with 10% weekly bets (ie. puts on about $40k of underlying a week) . My data showed that if I sold the puts every week with a strike by 10% out of the money from the opening price on monday, all the limit sale orders would execute within 4 weeks, and at the end of the year I would be 100% in cash, having effectively netted the put premiums less commissions. I don't have enough option knowledge to be able to figure out what those premiums would amount to - and in 2008, there were no SPY weeklies also, so there is no old quote data to look at. There is a question whether the premiums would be enough to cover commissions, with 10% lower weekly put strikes. In those weeks, I would just abstain from trading. I do know that this bullish strategy would still have have profited a little in that awful bear market :). Changing the put strike to 9% down, and I would end up with some unsold shares bought in october 2008 with an unrealized loss - the number of those shares would depend on the size of the weekly bet. It would take one year for those shares to get back to even.

    I did not try to figure out how well this does in bull markets, where the puts would never get exercised and I would be in cash 100% at the end of each week (my ideal scenario).

    I have a lot of questions.

    the main variables in my strategy are :

    a. size of the weekly bet (ie. number of put contracts sold). This seems to be one of the most critical elements, and it's completely under my control. With a $400k principal and SPY at $124, the decision would be to sell between 1 and 32 contracts each week. Obviously I wouldn't go for 32 all at once. It would more likely be between 1 and 4 at a time.

    b. the strike price of those puts
    Again, all up to me. Based on the 2008 data I used, the odds of assignment were close to 0% for 10% OOM put. They are in theory 50% for ATM puts.

    c. premiums collected for those puts
    I read about Black-Scholes, and the binomial method. But there are a lot of input variables. I don'really t know what to put in my backtesting spreadsheet for this. All I have input right now is the SPY weekly open, low, high and close. I am afraid this is not enough to calculate the premiums, without having the volatility. But it would be very useful to have at least some idea of the premium range.

    With 10% OOM puts, the weekly premiums right now are small, barely above commissions, or even sometimes less. The juiciest premiums are with ATM puts. I am backtesting with a variety of strikes to see which one is best. If the premium is high enough, I don't mind holding a few shares along the way even if they decline short-term, as long as the majority of the portfolio stays in cash.

    d. how often the put is assigned . Particularly, how often the early assignment occurs when the put goes in the money temporarily. This would drive up the commissions since there would be a buy each time. For example, if I sell 4 put contracts, and the price declines, each contract could be assigned on 4 different days, resulting in 4 buy commissions. Does anyone know the odds of that ?

    e. when assigned, whether the underlying (SPY) goes back above the put price short-term. Holding a few shares for 4 weeks is totally OK with me. more than 6 months would start to bother me. Especially if it happens repeatedly. I plan to backtest a lot.

    OK.. How is that for a first post ?
  2. ASE1245


    You sound way to risk adverse for options or equity strategies. If the risk-less rate is near zero, you will have to risk your assets to make a higher return. If you want to go through the learning process of options trading, you have to assume some losses. Also, paper trading is NOT the same as real trading. There is no fear and no greed. You never know what you'll do with an options position with a big near term loss or gain with paper trading.

    Make the decision as to what % of your assets you're willing to commit to a higher return, and possible loss, and what % you want to protect. Then, start small. Have fun. Ramp up slowly, and you will need a margin account to trade options properly. You can't sell options in a cash account. I would suggest a portfolio margin account, you don't have to use the excess leverage just because it's there.

    Set up an LLC, fund the account with the assets your willing to commit to trading. That will separate your trading account from your personal assets and limit losses to the LLC.

    Good luck,

  3. Daal


    You want to make 1% a month 'safely' in options?You might want to check out Madoff Securities I heard that generate that with split strike conversions
  4. Why is your post so short. Next time write a novel simply to ask a few basic questions a lot of which can be answered by actually putting out some time and effort on your part to study and learn, and then asking about those concepts that you need some further input about!! But then why do that, when you can ask people on a trading forum to do your work.
  5. If you are unwilling to be assigned. DO NOT SHORT OPTIONS CONTRACTS.

    Assignment is part of the buisness.

    I get assigned.

    I sell options on the index etfs. but I always factor in assignment risk.

    This means.

    #1 You must have enough capital to take stock when assigned.
    #2 You must use funds you are willing to have tied up for trading.

    Selling options on the SPY ETF is a pretty conservative way of going about it. But only do it if you can take the stock.

    For example you might sell the SPY 117 strike for november (which I did) for 2.25 a contract. (85 contracts)

    November comes SPY plummets to 107.50 . Lets say you get assigned.

    now you have SPY on your account you paid 115.25 but your underwater by 7.75 points.

    Now you have to sit on your hands and wait for it to go back up, Sell deep OTM calls for the next month or sell and take a loss.

    You need to think this ahead of time before you do your trade.

    Your thought process should be before entering a trade.

    #1 Take into consideration assignment risk.
    #2 Plan accordingly when assigned. What is your plan?
    #3 execute your plan.

    Options is not daytrading, it is a slower process and more planning involved. It can be quite profitable but it requires lots of thinking before the trade.

    Also Options trading is pretty capital intensive. I primarily sell short IWM and SPY puts and calls(covered) but I maintain a large cash position and a large underlying inventory of both etfs.

    I want to add that BS or Binomial options pricing is just a "Ruler" to measure.

    Just like using a ruler to tape measure an individual for a suit. You might measure them at 36 but that does not predict anything, what if over the weekend the individual got Cholera and now measures 34 inches?

    The tape measure did not predict cholera.

    The tape measure (BS or Binomial) is just a tool to let you measure the option and then use the measure ments to calculate how pricing impacts the movement of the options pricing movement.

    So you can say if the options delta is .50 that means one short put is the equivalent of 50 shares of the underlying. And you can then say, okay if the underlying goes down one point the options price will move .50 up or down.

    where then gamma lets you determing how the movement of the underlying 1 point how does this now effect the delta. So if Gamma is .10 then if the stock moved 1 point now the delta is .60

    Anyhow. It is good you are chosing SPY for your underlying.

    Too many fools chase single stocks with high IV's for options writing only to be wiped out.
  6. spindr0



    Consider asking fewer questions per post :)

    Best broker depends on the tools you need, the frequency of your trades and the size of your trades. A fee per contract/share is better for the small positions whereas a flat fee commission tends to be better for larger psoitions.

    Covered calls are equivalent to naked puts so the downside risk is the same.

    You need a margin account for short options. That's not the same as trading on margin where you borrow. So cash account trading is irelevant.

    Don't get caught up in keeping things simple (buying puts to protect the downside. If your objective is consistent gains, you need to have near perfect timing and selection and that's not going to happen. Next choice is good money management. Long puts can facilitate that. With an income oriented objective, you can't afford big blow out yeas.

    OK, my attention span has is shot. Others can deal with the rest of the questions :)
  7. newwurldmn


    You can do buywrites in a cash account. You can also buy options in a cash account. You cannot be short naked calls and and buywrite or short put must be cash secured.
  8. spindr0


    YEh, I knew that but I worded it incorrectly. Meant naked not short. Can I still stay here ? :)
  9. newwurldmn


  10. spindr0


    Gee, like I haven't heard that one before!

    :D :eek: :)
    #10     Nov 11, 2011