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One other IMPORTANT issue. Have a plan for what you will do if the
short call gets early exercised and there is still time premium in the
long option. If you exercise the long option to deliver you throw
premium away! You may not care but it might help to know in advance
your brokerage houses policy on what is called "same day substitution".
<P>David Donhoff wrote:
<BLOCKQUOTE TYPE=CITE> <FONT COLOR="#0000FF"><FONT SIZE=+0>OK, William...
I'm going to answer your questions embedded in the text below. Hope
you and everyone can read it OK.... I'm doing it in blue to make it stand
out from the existing text.;</FONT></FONT><FONT SIZE=+0>>Dave,</FONT>
<BR><FONT SIZE=+0>>Thank you for your expert advice and willingness to
help.<FONT COLOR="#000000"> </FONT>Here is a trade I would like your
opinion on. Two days ago, I have just<FONT COLOR="#000000"> </FONT>started
a debit bull calendar spread (Did I name this spread right?) on LCOS.</FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>Yes...
technically you are correct in naming the position... however what you
are REALLY doing is better explained as a SYNTHETIC COVERED CALL, or COVERED
LEAP CALL. For many new options traders, this will make it much easier
to mentally grasp. You've created a position with a fixed and limited
upside (profit) and an unlimited downside (risk/loss). Read on...</FONT></FONT> <FONT SIZE=+0>I
have a bias as to its increasing in price in the near future due to its<FONT COLOR="#000000">
</FONT>recent stock split announcement. The stock was trading at
around $60 before<FONT COLOR="#000000"> </FONT>the announcement, and up
to $100 intraday during the announcement. It has<FONT COLOR="#000000">
</FONT>dropped down to $65 last month. Today, LCOS closed at $77.625.
The split<FONT COLOR="#000000"> </FONT>will be reflected on 8/26.</FONT>
<P><FONT SIZE=+0>My stragegy was to make use of time decay Theta.
The trade was as follows:</FONT>
<BR><FONT SIZE=+0>Long a Leap call option Jan99 @ $50 strike price for
$28.50 when the stock<FONT COLOR="#000000"> </FONT>price was $72 two days
ago. So the time premium was $6.50 for 5 months.</FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>OK,
so you went long a deep ITM strike option (50 strike when LCOS was at 77-80),
thereby having a very high Delta... probably well over 95 (percent correlation
to the underlying asset's price), and also a very low Theta (rate of time
decay). You've effectively bought a proxy of the LCOS stock at a
fraction of it's actual price. Good job IF you want to be same as
long the stock.</FONT></FONT>
<BR><FONT SIZE=+0>At the same time, short a call option Sep98 @80 strike
price for $5.625. The<FONT COLOR="#000000"> </FONT>idea was to take
advantage of the high volatility and premium of the Sept @80<FONT COLOR="#000000">
</FONT>call. So my net debit was $22.875 plus commissions.</FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>OK,
so now you've sold a call virtually At-The-Money, thereby having close
to a 50 Delta (a 1/2 correlation in price movement to the underlying asset...
moves half as fast up or down in price, compared to LCOS stock (and your
LEAP), at this stage), and just about the most significant rate of Theta
(time decay) you can get in this position. You've sold the option
with expiration in the closest available date, which is one of my cardinal
laws (broken only in very rare occasions.) If the stock stays in
a pretty close range, your short call will continue to have a healthy daily
rate of decay (Theta.) If LCOS climbs, your short option will be
going deeper ITM, and will begin to accumulate INTRINSIC premium value
(cash-exercisable value) which obviously won't decay through time.
The higher LCOS climbs, the less your covered-call spread will be able
to make, until it ultimately reaches the predetermined maximum, as you've
calculated below.</FONT></FONT> <FONT SIZE=+0>Possible outcome
of the trade:</FONT>
<BR><FONT SIZE=+0>>(a) If the stock goes above $80 before expiration and
I get called out, I will</FONT>
<BR><FONT SIZE=+0>>in effect get $80 - $50 for my $22.875 investment, =
a return of 31% for one</FONT>
<BR><FONT SIZE=+0>>month.</FONT>
<BR><FONT SIZE=+0>></FONT>
<BR><FONT SIZE=+0>>(b) Or I may buy the Sep $80 call back one day before
expiration for the</FONT>
<BR><FONT SIZE=+0>>amount being in-the-money, and write a new Oct slightly
out of the money call</FONT>
<BR><FONT SIZE=+0>>or slightly in-the-money call for an additional $2 to
$4 time premium for the</FONT>
<BR><FONT SIZE=+0>>next month.</FONT>
<BR><FONT SIZE=+0>></FONT>
<BR><FONT SIZE=+0>>(c) Or if the chart shows the stock may be declining,
I shall write an in-the-</FONT>
<BR><FONT SIZE=+0>>money call.</FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>Yes...
this WOULD BE the "plan"... however I urge extreme caution as you may have
noticed the old saying that "The markets warily climb the long wall-of-worry,
and quickly slide down the slippery-slope-of-hope."</FONT></FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>Most
traders find it very difficult to keep their flesh attached when the sharks
start attacking the bid-ask-spreads, and we want to make adjustments in
the heat of a decline. There are ways to place limit orders using
"contingent on" orders that will replace your fading short call with a
deeper ITM short call in the case of a collapse.... but you'll still be
subject to the mercy of the traders in the pits (who are salivating as
they read this!)</FONT></FONT>
<BR><FONT SIZE=+0>></FONT>
<BR><FONT SIZE=+0>>(d) If the Sept $80 call expires worthless by Sept 21,
I can sell the Jan99</FONT>
<BR><FONT SIZE=+0>>$50 call if there is good profit.</FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>Since
you established your spread (locked your profit parameters) and went long
the J99 50 Call LEAP when LCOS was at 77... your short could only expire
worthless with LCOS less than 80... and after minimal Theta decay on your
LEAP, in order for it (the LEAP) to be profitable, LCOS would almost certainly
have to be above 78-79... a pretty small target to hit, wouldn't you say?</FONT></FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>If
you're going to want to liquidate your LEAP at a profit, you're probably
going to need to have an upward thrust above 80 to do so (because options
that far forward, and that far ITM are very sparsely traded... so the floor
will tend to widen the Bid-Ask spread, cutting sharply into your returns)...
which puts you back in the boat of just simply being long the stock (or
it's proxy equivalent) without any hedging. Not bad if you're confident
in LCOS... but hardly strategically covered.</FONT></FONT><FONT SIZE=+0>></FONT>
<BR><FONT SIZE=+0>>(e) Or I can write an Oct call and collect the premium
at about $2 to $4 per</FONT>
<BR><FONT SIZE=+0>>month in time premium (hopefully, unless the stock price
drops significantly).</FONT>
<BR><FONT SIZE=+0>>I shall repeat the process montly until Jan99.
Then sell the Jan99 50 call</FONT>
<BR><FONT SIZE=+0>>which should (I hope) still be deep in the money at
that time.</FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>Regardless of the
woes the Dow or the S&P may see in the next few weeks or months...
I'd have a hard time betting against the growth in the internet sector...
so in the long run, you're probably not in bad shape at all to be long
LCOS. One thing about holding long options though... another of my
"cardinal laws" is to sell or roll-forward (sell and buy as a spread) any
long positions 30-60 days before expiration, to avoid an accelerating Theta
(time decay.) In the case of LEAPS as you are using them, I'd probably
stretch that law to 3-4 months before expiration.</FONT></FONT><FONT SIZE=+0>></FONT>
<BR><FONT SIZE=+0>>(f) I would lose money if by Jan99 the stock drops to
below $50 + my net debit</FONT>
<BR><FONT SIZE=+0>>less the monthly time premium I collect every month,
which loss is possible</FONT>
<BR><FONT SIZE=+0>>due to the volatility of the internet market.
Right? But I don't know how to</FONT>
<BR><FONT SIZE=+0>>evaluate that.</FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>Forget
the "by Jan99" business... in this trade, whenever LCOS drops to have your
spread re-sellable for less than you paid for it, YOU ARE LOSING!!!
Covered Calls are NOT for schizoid markets!!! If this baby dumps
and you're not prepared... your trade goes right along with it.</FONT></FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>EOD
closing print today on LCOS is 34 1/4, post-split. That's 68 1/2
pre-split. I'm afraid to say it, but I'd predict your spread is already
in the red.</FONT></FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>Again,
I don't think it's bad over the long run... but you've got to take some
quick defensive action!</FONT></FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>What
you actually do is, of course, going to be up to you... and you will be
the one who profits, or suffers the consequences... below are a few
things to consider, but I can't make any recommendations AT ALL because
I'm at a bit of a loss to the specifics of LCOS history, news, and temperament...
and I'm not sitting in YOUR gut/mind.</FONT></FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>Some
of your options;</FONT></FONT><FONT COLOR="#000000"><FONT SIZE=+0>If you
think LCOS may dive a little or a lot, but ultimately come back up;</FONT></FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>Buy
deep ITM puts, 3-4 months forward. These will equilize some of your
Delta, and cover your risk in a short-term downslide. Use these as
covers on a "scalping" basis... i.e. keep them on only until you see an
"all clear" signal that the markets have clamed down, and start marching
up again.</FONT></FONT> <FONT COLOR="#000000"><FONT SIZE=+0>If you
think LCOS is going to dump fairly quickly in the short-term;</FONT></FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>Buy
back in your short 80's (now 40's) and sell ITM Sep calls (maybe 35, and/or
32 1/2).</FONT></FONT> <FONT SIZE=+0>If you think LCOS is going to
H&LL in a hand-basket... and THEN coming back;</FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>Buy
back in your short 80's (now 40's) and sell DEEP ITM Sep calls (maybe 30,
and/or 25). Stay ready to buy them back in when the dump stops...
and you better be quick about it! The "dead cat bounces" don't tend
to hang around for the sleepy!</FONT></FONT><FONT SIZE=+0>></FONT>
<BR><FONT SIZE=+0>>I don't know what other exit stragegies I should look
at.</FONT><FONT SIZE=+0>>And if the stock does go above $80, should I choose
(a) or (b)?</FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>That's another entire
letter.... but for now, let's look at the fact that you've established
a basic spread with a maximized, limited possible profit. You know
how to place an order that reverses your spread, and you know at what upside
price LCOS offers you no more profit... so place a contingent order to
reverse the spread at market when LCOS is at or above that price.</FONT></FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>You
know that as LCOS dumps, so does your kid's college funds... so look at
your charts (stocks or astrology or marine topography... whatever works
for you), look even HARDER at how strong your guts are for losses... and
decide at what print downward LCOS has just dug the grave too deep.
Place another contingent order to bail out at market (the wolves are howling)
when LCOS is at or below that price.</FONT></FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>Make
the two orders OCO (one-cancels-the-other) so your broker doesn't have
to freak about accidentally getting filled both ways (don't worry, on THIS
trade it wouldn't happen... period!)</FONT></FONT> <FONT SIZE=+0>>Would
this strategy work better on OEX, SPY (what else)?</FONT>
<BR><FONT COLOR="#0000FF"><FONT SIZE=+0>Hooyyy.... that is a BIG question.
We'll save it for another time, OK.</FONT></FONT><FONT SIZE=+0>></FONT>
<BR><FONT SIZE=+0>>Would this strategy work on a declining market?
A tradig range?</FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>This strategy
will work best in a steady, ranging market, OR a slowly climbing market.
If you're a market "timer" and you nail the beginning of a slowly climbing
bull JUST AFTER a sharp decline, you'll REALLY rack up the profits.</FONT></FONT><FONT SIZE=+0>></FONT>
<BR><FONT SIZE=+0>>Thank you very much. Sincerely,</FONT>
<BR><FONT SIZE=+0>>William W</FONT> <FONT COLOR="#0000FF"><FONT SIZE=+0>My
pleasure... and I hope it helps.</FONT></FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>Big
Profits to you,</FONT></FONT><FONT COLOR="#0000FF"><FONT SIZE=+0>Dave Donhoff</FONT></FONT> </BLOCKQUOTE>
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</x-html>From ???@??? Thu Aug 27 22:00:42 1998
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Date: Fri, 28 Aug 1998 12:55:25 +1000
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From: "peter" <derivatives@xxxxxxxxxxx>
To: RealTraders Discussion Group <realtraders@xxxxxxxxxxxxxx>
Subject: Re: ph"Y"chological spelled without a "Y", do you know why?
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Gary.
I second the opinion presented below. Maybe you should really
consider the importance of your posts in a trading environment rather than
endlessly blow your horn.
Best regards Peter
>
>Gary,
>
>I'm glad that your puts are working out but I hope you also realize that
there
>are those of us who actually daytrade as well as position trade for a
living.
>I personally take my work very seriously and my time is very valuable so I
>would appreciate if you did not clog up the RT mail system with matters not
>related to trading. May I suggest that you pick up a good book to read
next
>time you get bored.
>
>Happy Trading
>
>Dev
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