OPTIONS (PUTS)- great info (easy to understand) from THE VET and others

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#1 Thu, Sep 1, 2011 - 4:12pm
terri5125
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OPTIONS (PUTS)- great info (easy to understand) from THE VET and others

From THE VET-- If you believe that SVM is way undervalued here (as I do) then take the shorts on...

Sell as many of the September $7 strike puts for 45 cents as you are prepared to buy SVM stock.

If the price is below $7 in 16 days then you have bought SVM for $6.55 a share a huge discount from the present price of $8.40.. If it doesn't drop below $7 then you have .45 share pure profit for zero outlay ($45 a contract less commissions) I'm loaded with them but the shorts are still giving the money away!

From THE VET- I sold into all the 50 cents offers of the SVM Sep 7 strikes and picked up a total of 88 contracts. I doubt that I will be assigned but even if I do I will have 8,800 SVM at $6.50 a share. Most likely I will just end up with the consolation prize of $4,400 cash (which of course I have already collected into my accounts).

If anyone is prepared to wait a little longer and take a little more risk the October 7 strikes are in demand at $1.15... 51 days to wait and you either make $1.15 a share with no outlay or you buy SVM on October 22 for $5.85 a share. I don't know if something bad is going to happen to SVM before then that would cause it to crash below that, but the charts don't seem to show anything like that as likely.

However rule No. 1 is ONLY SELL PUTS on stocks that you are prepared to buy!

From TOM L- I am prepared to close my long calls that have any value left in Sept. by early next week (Tues. close at the latest) and taking my lumps and moving on. Play with a Black-Scholes calculator long enough and you can see how time works against you. It's not rocket science.

I've linked it before, but it's worth linking again. This will solve for you the value of your option from a number of different perspectives... the most important one is time.

https://www.optionistics.com/f/option_calculator

I didn't buy my first call until I had found one of these. H/T to my good friend DX who just finished his MBA and explained to me how important that equation is to the entire derivatives market.

Ta,

From THE VET- The high volatility in SVM is one of the major reasons the option premiums are so high, and it also means that the premiums will remain high right up until very close to expiry, when they will collapse very rapidly for the current month.

If you are short puts or calls, then hold them right to the bitter end and don't try to close them out early even as they seem to be not responding as you expect. For sellers of options time is on your side.

If you are long calls, be prepared to close out your position well before expiry as those positions will rapidly drop to the intrinsic value as expiry approaches.

I both case simply subtract the stock price from the strike price and compare that figure (which is the time + volatility premium) with the bid or ask respectively (depending on whether you are buying or selling to close).

From THE VET in answer to DarkPurpleHaze question- Am I wrong that I would never have to worry about covering the shares in my puts if I held them out a bit further in time and kept rebalancing my positions out in time?

Does holding the puts out in time go you peace of mind and not really having to keep all of that capital on standby just in case they were called in? What"s the likelihood of going 3 months out and getting your shares called in? Does it just depend on what the share price is and the volatility at the time?

Properly managed short puts rarely get "put" unless you want to be assigned the stock.

Selling puts is a bullish strategy. While you are short the put you are actually bullish and make most of your money in bull markets.

Always monitor the time value of every open short put position to calculate the odds of being assigned the stock early. If it goes to zero or is negative then look to roll the position (or close it). I have some short positions which I have rolled forward for years. They are in the money and in theory could be assigned to me at any time, but it doesn't happen because they have positive time value. This is simply because the buyer of that position on the other side of the trade can close the option position in the market for a better profit than he can make by assigning me the stock. Simple really!

Rolling forward to future months generates more income as it can almost always be done for a credit. I always do this as a two legged combo order either a straight roll to the next month at the same strike, or a diagonal to a different strike price (may be higher or lower depending on my view of the stock and the market).

I tend to hold a lot of small positions in as many different stocks as I can manage comfortably. I have 130 options positions open at the present time, mostly short puts but some long calls which I get for free by using synthetic positions explained earlier.

Selling puts makes good money, but you don't get multibaggers. You can run a portfolio completely with naked puts but I prefer to hold some solid marginable dividend paying stocks as well to provide support. Always keep track of your exposure to ensure you have an escape strategy in a really bad market crash.

and don't forget rule No 1. Only sell puts on stocks you would be happy to buy at the strike (less premium) price.

From ERIC- Here's a little something about the strategy that I think the The Vet is talking about. I've been kicking this one around in my head as well. I've sold puts, and I've bought calls, but haven't as yet done them as a pair for a particular "strategy". I think the strategy is sound.

https://www.theoptionsguide.com/synthetic-long-stock-split-strikes.aspx

From THE VET- So, if I understand this right. I should sell 5 puts at $0.50 and be prepared on 9/16 to have $3500 available to buy 500 sh @ $7.00/each. These are realistic numbers given my acct. balance and potential allocation. This only happens if the stock closes below $7.00 on 9/16.

  • You have that right. If you have a little more time up your sleeve, the Oct $6.00 strikes are still bid at .80 cents and need an extra $1 drop before you will be assigned.
  • With those, you sell your 5 contracts for .80 ( $400 total credit) and make sure you have $3,000 available to buy on October 22 should SVM be below $6 at that time. Your net cost would be $5.20 a share, or alternatively just keep the $400 if SVM expires higher than $6
  • Am I wrong that I would never have to worry about covering the shares in my puts if I held them out a bit further in time and kept rebalancing my positions out in time?
  • Does holding the puts out in time go you peace of mind and not really having to keep all of that capital on standby just in case they were called in? What"s the likelihood of going 3 months out and getting your shares called in? Does it just depend on what the share price is and the volatility at the time?
  • Properly managed short puts rarely get "put" unless you want to be assigned the stock.
  • Selling puts is a bullish strategy. While you are short the put you are actually bullish and make most of your money in bull markets.
  • Always monitor the time value of every open short put position to calculate the odds of being assigned the stock early. If it goes to zero or is negative then look to roll the position (or close it). I have some short positions which I have rolled forward for years. They are in the money and in theory could be assigned to me at any time, but it doesn't happen because they have positive time value. This is simply because the buyer of that position on the other side of the trade can close the option position in the market for a better profit than he can make by assigning me the stock. Simple really!
  • Rolling forward to future months generates more income as it can almost always be done for a credit. I always do this as a two legged combo order either a straight roll to the next month at the same strike, or a diagonal to a different strike price (may be higher or lower depending on my view of the stock and the market).
  • I tend to hold a lot of small positions in as many different stocks as I can manage comfortably. I have 130 options positions open at the present time, mostly short puts but some long calls which I get for free by using synthetic positions explained earlier.
  • Selling puts makes good money, but you don't get multibaggers. You can run a portfolio completely with naked puts but I prefer to hold some solid marginable dividend paying stocks as well to provide support. Always keep track of your exposure to ensure you have an escape strategy in a really bad market crash.
  • and don't forget rule No 1. Only sell puts on stocks you would be happy to buy at the strike (less premium) price
  • From INBETWEEN IS PAIN- Someone mentioned the old saw that you shouldn't sell puts on a stock unless you're willing to own it. I'm not sure where this piece of "wisdom" came from, but it really doesn't make sense. While, yes it should be a company that you would be willing to own, it doesn't make sense to have it put to you if the price drops unfavorably. Why should you have to buy it? If you're an option player this just unnecessarily ties up capital and increases transaction costs (slightly). The better solution, if you still believe in the stock, is to roll over the options to the next or a more distant month. Unless the stock goes to zero, you can almost be certain to at least break even eventually. The main thing when selling puts is not to over-leverage yourself (i.e., don't sell too many), as I've discovered from painful experience.

    From THE VET- the old saw that you shouldn't sell puts on a stock unless you're willing to own it...

    It's good advice for new options traders, but the rule is never sell a put on a stock that you are not PREPARED to own... That doesn't mean you should expect to own the stock or even that you intend to own it; it just means that if you are selling the put in a stock you should do the same DD as you would if you were buying it.

    You are correct in that very few put options ever result in assignment and in a properly manged short put portfolio unexpected assignment should be a very rare event. I have had many thousands of short put positions open for considerable periods (often multi - year leaps) and have been assigned just 3 times. One of those 3 was for a single contract in a 100 contract positions and one I intended to get assigned as a cheap way to buy into the stock.

    From INBETWEEN PAIN- By the way, something few people realize is that the risk and reward characteristics of selling naked puts is exactly the same as selling covered calls. You heard that right. People always think that selling naked puts are risky but it's no more risky than a covered call strategy. The risk involves being over-leveraged.

    From BACKSEATDRIVER- I can tell you that money management is the key to any trading system. Identifying your initial Risk and share sizing it for the stop is part of it. Ex: $100 risk, .15 cent stop equals a rounded up figure of 700 shares. If the stop is .20 then share size is reduced to 500 shares to stay with same risk amount. I can tell you that good traders know their systems stats. They know their avgs (winners, losers) and how many R's (return on risk)they net on a winner vs a loser. The share sizing above keeps a constant (R)isk of $100. If my losers are -.5 R then I lose $50 on a loser. If I net 2R's on winners then I get $200. If my avg is .500 then my expectancy is: 5 losers x $50= -250 5 winners x $200 = 1000, 1000-250 = $750 is my expectancy every 10 trades. Good traders know these numbers and have tested their system so they can feel confident and execute their plan and not place too much emphasis on any one trade but know on the whole that their system will net the expected results. I can also tell you that the elite traders always start with small positions and build a bigger one as the trade goes their way. They lock in small profits along the trend and look to add on pullbacks while keeping their AVG price below the stop point (long trade). This way if the stop is hit, the remaining profits get locked in.

    Most traders fail because they put on too much risk for too little return or they keep adding to losers and get run over by the trend that won't quit. The good traders start small and once they know they caught the trend they start building it up. The key is knowing where current price is, your avg cost, and where your stop is and making those adjustments along the trend.

    I got all of my advice from a former college baseball team mate of mine. I think everyone who trades should try to find a mentor. It makes things so much easier. That is why Turd is a legend already. There a many mentors and people much smarter than I on this site and I continue to learn from them!

    From KC- Don't have time for a long post....I think that one of the least appreciated and understood component of options is the "hidden" expenses. If you transact a lot, the hidden expenses will kill you. For example, if you are looking at an options quote that is .15-.25 (the bid is 15 cents and the offer is 25 cents), you can ballpark that the theoretical value of the option is somewhere in the middle. Let's say 20 cents. If you use a market order and sell this option at 15 cents, you have sold something for 15 cents that is worth 20 cents. The "true" value of the option has to decline by 5 cents (25%) just for you to break even. Add on your commissions, and these numbers will eat you alive.

    Right now the SVM sep. 7 put is .40 bid .50 offer, while the december 7 put is 1.6 bid 1.7 offer. The longer time horizon reduces the "vig" that you pay. I much prefer to seek out lower bid/ask spreads and ALWAYS use limit orders. If you are new, it is definitely in your best interest to transact as little as possible. The Dec SVM is a good opportunity. A limit order at 1.65 for 3 contracts would give you almost exactly $500 in premium. Your total risk capital would be $2100 for the 300 shares. That's a pretty sweet return for 3.5 months. Worst case scenario is that your cost basis in SVM is about $5.45 per share. Ciao

    From THE VET- When I refer to time value I'm using a simplified approach that options purists will decry. The traditional option pricing and valuation models involve some complex math, which actually doesn't mean much to traders, but is essential for the market makers to allow them to set prices.

    The intrinsic value is the difference between the present stock price and the strike price. It can be positive or negative depending whether the option is in or out of the money. If it is exactly at the money (ie. the strike price and the underlying stock price is the same then intrinsic value is zero and the option price is the time value.)

    The time value is the difference between the intrinsic value and the option price. For all out of the money options all of the option price is time value, and negative intrinsic values are ignored. For in the money options the time value is the option price less the intrinsic value.

    Hope that helps a little...

    From THE VET--Always use limit orders for all options trades. Don't just take the bid or ask especially if the spread is wide. Try something in the middle and if you don't get filled just walk away.

    If you are prepared to hold until expiry then the spread and commissions are not much of an issue but it is if you want to close a position early.

    Also if you want to trade options a lot, check out a high volume popular stocks with options at 1 cent steps rather than those denominated in 5 and 10 cent steps. The difference can be very significant.

    From TOM L--That's what I thought you said earlier, thank you for clarifying it. So, as a concrete example. I'm looking at SVM.

    Current price = $8.53.

    Strike price, for example, = $7.00

    Intrinsic Value = $1.53 ($8.53-$7.00)

    Option Price For Sept $7 Put = $0.45

    So Option Time Value = $1.08 ($1.53-$0.45)

    As long as that value is positive hold the naked put. If it approaches zero, cover and move out in time to avoid being 'assigned' unless that is your plan.

    Ta,

    Edited by: terri5125 on Nov 8, 2014 - 5:16am

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