I shot myself in the foot and limited my gains in the recent cocoa kamikazi dive by setting up the following spread on 7/10: 2-long Sep-1750 puts = -1400 2-short Sept-1650 puts = +600 --------------- net = -800 after the fall, I closed out the spread: bought 2 Sept-1650 puts = -2400 sold 2 Sept-1750 puts = +5250 ---------------- net = +2850 OVERALL = +2050 (+256%) I was thinking that the unlimited losses in the short side of the spread really cut into my gains. Looking at it again, seems like using a long straddle with buying 2 Sep-1800 calls for $1800 would've been a better bet than selling those puts? I'd have a fixed amount that I could lose and it wouldn't increase in-step with the winning side. I would've made +430% instead if I had done this, even with sacrificing the long calls. Looking at the options listing, it appears the break-even point with the ITM side doubling to cover the cost of the OTM option is only 2-3 strike-prices away. It appears most of the commodities like wheat, corn, coffee has moved more than enough in the past 6-months to make it profitable to not even bother worrying about predicting price-movements. Just set up a straddle on either side of the closing price and it would be a sure winner? What do you think? Chart of Sept. COCOA Options on Sept. COCOA
I was thinking that the unlimited losses in the short side of the spread really cut into my gains. Well, sure. Selling anything on a move of that magnitude will cut into your gains. The best would have been to just buy the puts. The point of vertical spreads are to reduce cost, vega and theta exposure. Just set up a straddle on either side of the closing price and it would be a sure winner? I've taken the other side of that bet and won consistently over the past few weeks. Coffee, wheat, and corn. Coffee in particular. Had I done the same on Cocoa, I would have lost. You win some, you lose some. Particularly this time of year--corn, soy, and to a lesser extent, wheat are in a critical growing phase. Rain comes, IV drops by 25% and you're out of money big time on those long straddles. Take a look at cotton, lumber, cattle, or hogs. Straddles would have been definite losers for quite a while on those.
YOU ARE on the short side (meaning long atm-shortotm:you are paying i.e debit)... before doing a combo you should understand wich side you are pulling for. Sorry, My bad ... read too fast posted too fast ( but just too tell you they are no free lunches if by any chance there is a flaw in the pricing take advantage of it and it will be gone ...)
So are you saying I should sell OTM straddles then? Take advantage of stagnating prices and just collect the premiums?
(1) Cocoa very seldom makes big moves like that. (2) The maximum risk of a cocoa short-put position isn't infinite. It's "strike price minus premium". It's a "finite number", but still potentially large.
It depends on your market view. I sold premium because I felt the market was too worried about coffee (and way overpricing the options). As soon as the IV got sucked out of coffee, I got out and am looking for another opportunity. http://platinum.optionetics.com/cgi-bin/oamergef/www/tablesf/KC Scroll down a ways, and you'll see the IV chart for coffee. I sold in late June, and bought back about a week ago. I got into the trade because: 1) I thought IV was way overdone 2) I didn't feel the move they were pricing in was reasonable (repeat of #1, but from a different perspective--I thought the technical levels they were pricing in were unattainable) 3) I didn't think the fundamentals supported the move (repeat of #1, but from a fundamental perspective) I got out of the trade because: 1) I thought the IV was overly crushed 2) There was too little money left to be made in the short premium. I considered getting long premium to ride the bump in IV I expected to be coming. In short, my trade was almost exclusively a volatility one rather than a price action one. There's no "wash-rinse-repeat" action here. If there were, everyone would be doing it. Would you sell the long straddle to someone who made money all the time? At some point, they wise up and the IV goes up. Another way to think about it: The bid/ask spread is the consensus' view of arbitrage. Ideally, if you bought on the bid and sold on the ask (and held it forever) you would win in the long term. The probability is with the market maker either way. In short, the market maker is perfectly happy to either sell or buy that straddle--he doesn't care which because the odds are in his favor whichever one he does.
I guess I'm looking at trades from the underlying price-action instead of IV. Seems that the "cause" is the underlying price and the "effect" is IV? Is there an indicator that measures the relationship between the underlying price-value vs. IV in an option? And would that be something worth looking into? I've always made more money from playing off the underlying price by going long on barely OTM options: Danno's CMGI calls. I just appear to me that there's a limited returns on shorting options as the most you make is what you collect on the premiums. The most you can make is 100%. Whereas going long based upon the underlying price has higher returns? That's the basis behind my original question on using a long-straddle for the cocoa instead of the spread. Appears it would have two advantages: 1. limited risk, the most you have to lose is the premium paid on the losing side of the straddle vs. much larger losses on the short leg of the spread. 2. no need to predict price movements. On a stock/futures with volatile enough price-movements, the losing side of the straddle's more than compensated by gains on the other. I guess the underlying price's volatility has some connection with IV as well?
I guess I'm looking at trades from the underlying price-action instead of IV. Seems that the "cause" is the underlying price and the "effect" is IV? Careful. I've lost plenty of money being right about price action, but wrong on volatility. With options, you can't separate the two at all. Before an options trade, I look at the IV compared to historical values (I'm looking to make sure I'm not selling at a long term IV bottom or buying at a long term IV top). I just appear to me that there's a limited returns on shorting options as the most you make is what you collect on the premiums. The most you can make is 100%. Ah, but take the odds into account. You may have a 20% chance of doubling your money, but I have an 80% chance of keeping your premium. In the long term, I'll win. In reality, it doesn't quite work this way. But, like I said in the last post, the market maker is perfectly happy to either buy or sell you that straddle--that should tell you something about the odds and reward. 2. no need to predict price movements. On a stock/futures with volatile enough price-movements, the losing side of the straddle's more than compensated by gains on the other. Sometimes. There's a concept of gamma scalping you could look at too. I did some of this a month ago with SUNW. (I bought ITM 4 calls, and ITM 5 puts, and then gamma scalped the oscillations) Another common play for straddles/strangles is earnings. I spent a lot of time exploring this--if the stock moves 12%, you'll break even (in general). Depending upon the earnings period (ahem, like this one), this is either easy money (RACK, CKFR, AMZN, YHOO) or tough. I guess the underlying price's volatility has some connection with IV as well? Definitely, and not proportionally either. Take a look at Coffee. Put IV is in the 20% range, Call IV is in the 60% range.
Cool... thanks for the suggestions. I gotta get more educated and practiced with the more technical aspects of options. There's a whole lot more going on than with stocks.