Attached are two charts with calculated credit spread values for an 1140/1150 SPX bull put and an 1130/1140 bull put. Both charts assume 10 days to expiration. One chart is for a 15% volatility and the other is for a 20% volatility. The B-S pricer was used to calculate individual option prices assuming an interest rate of 0% and a dividend yield of 0%. It's interesting that the curves have a region that is essentially linear. With a 10 to 15 point distance between SPX price and short strike as a trigger, the credit spread value would be in this linear range. The vertical distance between the two curves at a given SPX price is the amount that would be lost by rolling the 1140/1150 spread down to an 1130/1140 spread. In the linear range, the loss doesn't vary as much as I would have thought. At a 15% volatility the loss is $0.83 at SPX = 1170, peaking at $1.39 at SPX = 1140, and then back to $0.78 at SPX = 1110. Nothing is included here on rolling any bear calls down or how much was initially brought in as credit. Interestingly, at a higher volatility, the loss from adjusting is theoretically less. Also, it's interesting (at least to me) that the loss from adjusting is not nearly as great as I would have expected once the short strike of the original position is ATM or even ITM. I think these curves support the idea that if one really feels that there is strong support at a level, then one can hold on longer before adjusting (i.e. maybe wait until 5 points or even ATM to adjust). It appears that you won't lose much more from the adjustment by holding on. HOWEVER, with an adjustment, the idea is that the adjusted position will expire OTM. If it doesn't, then that's a substantial loss on top of the adjustment loss. But it's late and I'm a little muddled in my analysis here, because the SPX will do whatever it wants to regardless of when one adjusts. So, for example, if strong support were at 1150 and the original position were 1140/1150 bull put, then whether one adjusts at 1160 or 1150, the loss from the adjustment is not all that different (let's ignore the accompanying bear call roll down for now). The SPX might still break this strong support and go down to 1140 regardless of whether I adjusted at 1160 or 1150. If I adjust at 1160, I guess I could adjust again at 1150, whereas if I wait until 1150, it's much more difficult. But in the end does one come out ahead if the SPX goes down to 1140? Since this example uses a strategy that assumes that 1150 is strong support, once that support is broken then maybe the only smart thing to do is bail out of the position. This is all theoretical of course and one has to consider b/a and so on. But if the position can be adjusted using a butterfly, then one should be able to remove the risk associated with sequential rolling of the spread. Also, I personally don't yet have a good feel for how days to expiration affects all of this. I thought I would just get the ball rolling and welcome comments and analysis.
Hi Coach, For the month I actually broke even before commissions. But, that was because I was not only doing IC's on SPX but on others too, like DIA, SPY, MNX as well as OEX. I was loosing on adjusting the DIA and SPY positions, so I just closed the whole spread and opened two SPX trades (IC and Bull Put Spread) to try to make up for it. Luckily, it worked out for me. I think I will concentrate more on SPX and XEO's this month. Might consider MNX later on after earnings season is over possibly since it still does give good premium. But, my question is, could you please talk about butterfly hedges again? How you use SPY butterfly to hedge aganist SPX IC and OEX Buttferly to hedge against XEO IC?? Do you talk about it in your book? Thanks.
Phil, These are my results for Oct as you requested. If my calculations are correct I had a 9% return after commissions. I am just getting my feet wet so limiting my investments for net dollars of $540. I am considering doubling the amount of investment this next month. I did not get a chance to try adjusting and am not looking forward to learning this technique any sooner than I have to---I think I followed the experience of others and hopefully will be able to react when needed. As a beginner I am not yet comfortable with the Greeks and can not follow some of the discussions with heavy use of Greeks. Hopefully they will become more clear as I gain experience. Any preferred references for the Greeks? I did learn that it is difficult to show column data in the forum. I see we are allowed "ET Code" for formatting. Where can I learn about this? Will this allow tables? Phil, Let me add my thanks for your effort in making this forum the learning experience that it is. Also thanks to the many contributors. Jack Date Qty Price Credit 09/21/2005 BTO 6 SPX OCT 1270 Call .85 .6 09/21/2005 STO 6 SPX OCT 1260 Call $1.45 10/10/2005 Close 1260/1270 Call Spread for .5 net profit. Then open 1125/1135 Bull Put Spread 10/10/2005 BTC 6 SPX OCT 1260 Call $0.15 -.1 10/10/20 STC 6 SPX OCT 1270 Call .05 10/10/2005 BTO 6 SPX OCT 1125 Put $1.05 .4 10/10/2005 STO 6 SPX OCT 1135 Put $1.45 10/12/2005 Added the 1210/1220 Bear Call Wing of the IC 10/12/2005 BTO 6 SZPJD SPX OCT 1220 Call $0.50 .55 10/12/2005 STO 6 SZPJB SPX OCT 1210 Call $1.05 The IC expired worthless and kept the premiums of .4+.55 = .95 The total premium for Oct was .9 +.55 = 1.45. If I understand the calculation of return correctly this would be 14% for the month of October. In real dollars the net income was $540 on $6000 for net return of 9% after commissions.
The butterfly hedges came about as a way to reduce the cost of the bull call or bear put spread and only work when time to expiration is a few weeks out due to the need for theta to shrink the body. I do not think butterflies are my first choice for partial hedges. Long puts or calls, followed by bull call or bear put spreads, and then butterflies if the price is small enough. The SPY FLY made some money in OCT but the OEX FLY did not. So the jury is still out on the best way to use FLYs here as others have offered different suggestions. I will discuss them the next time the opportunity to hedge comes up to put the numbers in real perspective. This strategy and follow-up adjustments are not covered in the book unfortunately because of time limitations and the fact that they are more complex and could take up its own book. Also, the book outline started in early 2003 and I was not as heavily involved in these spreads so it was not addressed in detail (I was trading mainly OTM put ratio spreads and those were covered more frequently as adjustments in certain circumstances, later I morphed more into credi spreads). Perhaps I will write a book on this strategy but then I will be accused of being a con man and acting unethical by some.... Best first choices in partial hedges with SPY is long outright or the spreads. I will grab an OTM FLY if I can get it for a cheap price but still refining this approach. Same with OEX on XEOs. Phil
Coach, Thanks for your response. I would also like to take the time to thank you for starting this thread. You have really helped me a lot in my endeavor to learn about options and the different strategies, both in this forum as well as the one that you started in Yahoo. I had always thought about this strategy, but I never knew some many were using it. This strategy seems like a very viable and lucrative one if implemented correctly. I was also wondering, if one were to get a group of investors and pool their funds together and trade on their behalf, how would they go by doing that? I know that Interactive Brokers has an Advisor Account service available. They have a type of account called, "Family and Friends" account for non-registered advisors. I'm assuming those are people who don't have Series 7 or 63 licenses. Granted they have some limitations, (can't oversee more than 12 accounts and can't exceed $25 million) could anyone open up an account like that, and be legal? Thanks for all your help.
There are different ways to pool money legally. Investment clubs are the oldest format where no one individual is managing the money but all participate equally. Many books on forming and running investment clubs and although these have been done for stocks, no reason they also cannot be done for a certain option strategy. This choice is fine for family and friends getting together but just be careful of opening it up to anyone since you do not want to create problems or look like you are advertising a fund. Look under Amazon or at the bookstore for this approach. Some people pool together some family money and you can manage it if you without registering if you fall under the SEC and state law exemptions. So you could take Mom and Dad's money and pool it with yours. I cannot give you the specific legal advice and go through all the liabiltiy issues here but you can start with the SEC website or just GOOGLE the investment advisor rules and regulations and you will see the SEC exemptions. Then follow up and look up the rules under your state. After that you should have a good idea but to be clear I am not recommending anything specific to you. Phil
Forgot to pat myself on the back for 6 consecutive winning months! Actually the reaons I brought it up is to bring home an important point- not letting a series of wins take you out of your trading plan. Often when we have successes we are tempted to increase the amount of capital at risk and go for more profits. The greed takes over and we get that false sense of invulnerability. Then when the loss does come it usually comes in much larger magnitude and really hurts as opposed to a lose absorbed if we stuck within our means. The more money I make, the more nervous I get about when the loss will come in the sense that I try and put extra effort into keeping my greed in check. I already feel myself slipping and am very aware of working to continue my wonderful results to date. So take a moment to pause and review where you are at and review your risk management plans. Take a moment and step away to keep the greed in check and keep your focus on the long range goal and remember that the market has a rude way of slapping you in the ass. Even in Market Wizards, some of the traders talk about the danger of a long winning streak. Phil
I had an idea this weekend, thought I might try to implement it early this week. Since Rd and others are grabing some nice premium in the low 1100's I'm thinking of opening another PS say 1120/1110 might get about .80 then....on the call side go out to 1250 and go Long (cost about .55.) IF (and when) the spx goes up hopefully in the next couple of weeks then either do a call spread (sell 1235,1240,or1245) with the back stop in place or IF not comfortable with that perhaps the .55 will have increased. Reasoning: We've been bumping along the bottem yet 3/4 of the company's have reported better than expected earnings. Oil has droped considerably and gas prices are at least .50cents lower..with holiday's aproaching people are going to start buying, yes there is still worry about the Fed and 4th quarter and 06 earnings. (I'll probably be right but only after Nov exp:eek: )