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Hi Guy,
As usual other list members have stated their case much more eloquently than
I ever could. Read especially the comments of Gitanshu (of course) and
Moshe. There was one other post I really liked but I deleted it and can't
remember the name of the author (sorry).
So I decided to try and come up with an example that might illustrate what
I'm thinking. Lets say we have an index at 828 with 10 days until expiration
and we want to sell an at the money 830 put. According to my crude options
calculator and failing mathematical abilities that put should be priced at
about $15 if the volatility is 26%. So we sell 10 contracts and rake in
$15000 with just 10 days left until expiration. What if my volatility
estimate is wrong. Assume the volatility is 41% then the option price is
about $23. So I can now buy them back for $23000 and a loss of $8000. That's
with nothing changing but the volatility. If we hold these options till
expiration and the underlying doesn't change in price then we will
eventually buy them back for $2 or $2000 for the 10 contracts and a profit
of $13000. Not bad! These numbers are theoretical and probably wrong but
should be O.K. for discussion purposes.
My birthday is the first two weeks of April, April 10 to be exact but heh, I
like to party. In mid March the OEX hit a low of about 730 and then
rebounded. On April 4 it again had a mini crash and hit a low of about 770
and started climbing. By April 10, my birthday, it was looking pretty good
and I felt it would just continue to the sky from here. The OEX is at 822
and climbing. It tops out at 828. Euphoria! Lets sell 10 830 puts cause I
think we'll go nowhere but up. Right now they are priced at about $13 so
we'll take in $13000. I can buy a lot of beer for that price and probably
would too. April 10 is a Monday and all my friends and some I don't know
converge on my house for a pool party and associated bachanaalia. By
Thursday the kegs of beer had been replaced by cases of Tequila. I love my
birthday weeks. Somewhere in my stupor I wake up Friday morning and try to
look at a quote screen. Yikes! By Friday afternoon the OEX was down to a low
of 723. I am now one week from expiration and my 830 calls are now $107 so I
can buy back my position for a measly $107000. If the beer didn't make me
puke that surely would. And in those five days the VIX, which is a measure
of the volatility of the OEX, went from 26% to 41%. But when you're that
deep in do-do the volatility really doesn't matter.
I've read your posts for several years now and always enjoyed them. I see
you telling how you have to take kids to dentist appointments, meet with
friends, get sick, play with grandchildren and endure many other
distractions. In options trading if you blink, you're dead. On April 14 the
OEX went from a high of 769 to a low of 723. My deep in the money puts would
have gone down $46 per share or $46000 that day alone.
This is a hypothetical worst case scenario and I didnt't actually execute it
but I could have and it sounds like that's what you're contemplating. I did
sell a couple of AFFX puts in March for $3000 and was glad to buy them back
for $23000. So now I'm mastering spread trading. I'm also trying to master
sitting on my hands. I seem to make more money when I do that than any other
strategy I developed so far.
That's my two cents and probably over priced at that.
John Manasco
p.s. If anyone has historical pricing for OEX options and would like to plug
in actual values please do so. I just guessed at them but thought they were
close enough for the purposes of this discussion.
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