{"id":6987,"date":"2010-09-08T11:59:03","date_gmt":"2010-09-08T15:59:03","guid":{"rendered":"http:\/\/www.smbtraining.com\/blog\/?p=6987"},"modified":"2010-09-09T14:13:37","modified_gmt":"2010-09-09T18:13:37","slug":"an-old-options-pro-joins-the-smb-blog","status":"publish","type":"post","link":"https:\/\/www.smbtraining.com\/blog\/an-old-options-pro-joins-the-smb-blog","title":{"rendered":"An “Old” Options Pro Joins The SMB Blog"},"content":{"rendered":"

The goal of my blog is to teach traders about options.\u00a0 I started trading stock options back in 1985 making markets on the Floor of the CBOE.\u00a0 The changes over the past 25 years in some ways are good while others bad.\u00a0 My views come from looking from the floor outward.\u00a0 Computers have sped up the process but the game hasn\u2019t changed much.\u00a0 I moved off the floor in 2002 as did many others.\u00a0 If the SPX pit wasn\u2019t there the floor would make a nice indoor parking garage.<\/p>\n

My philosophy in ways is contrary since I was taking the opposite side of the trade (position not deltas).\u00a0 Most of the time I was always long extra units (options) in my book.\u00a0 The times which I was net short units seemed to always cost me huge.\u00a0 I\u2019d rather know what I can lose than not know the possible losses.\u00a0 There were many floor traders who took the opposite view and were always short premium and\/or volatility and were successful.\u00a0\u00a0 I just couldn\u2019t trade that way and sleep at night.\u00a0 Over my career on the floor I carried limit positions sometimes but also traded small (5 or 10 lots).<\/p>\n

My trading style did change a bit from the floor.\u00a0 Since your position is always changing while market making it was difficult to keep one on but off floor (since I\u2019m not making markets) putting one on is easy.\u00a0\u00a0 Over time I will present some old ways and techniques of trading which compliments current ideas.\u00a0 I compare it to using a calculator.\u00a0 One should know that 2+2=4 and how the process was derived rather than just plugging it into the calculator and assuming its right.\u00a0 In some ways the speed can be dangerous as we saw on May 6th<\/sup> (flash crash).<\/p>\n

I will also discuss insights and experiences along with some very funny and in some cases sad stories. The first area that will be discussed is the back spread.\u00a0 Currently I think the market is at an important inflection point meaning the market is about to move big!!<\/p>\n

THE BACK SPREAD<\/strong><\/p>\n

What is a back spread?\u00a0 It is when a trader uses an option and trades stock around the option position.\u00a0 In this example we will keep it simple and just use 1 strike price against stock.\u00a0 The main thesis behind a back spread is either volatility will increase or the intraday stock movement will pay for the daily Theta (decay). \u00a0Everyday options decay and the rate in which they decay are called theta.\u00a0 Theta is a very important component in determining how much it costs per day to trade the position.<\/p>\n

If an option has a decay rate of .017 per option owning 10 contracts would theoretically lose $17 per day assuming all other variables remain constant.\u00a0 In the example below the following data is known-<\/p>\n

Home Depot (HD) – stock price $29.85\u00a0\u00a0 Sep. 30 call .39\u00a0\u00a0\u00a0\u00a0 Theta .017\u00a0\u00a0\u00a0 Gamma .34\u00a0\u00a0\u00a0\u00a0 Vega .023<\/p>\n

Trading Days to expiration- 9\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Delta .46\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Assume variables remain constant<\/p>\n

A 10 contract position in HD would cost $390 to establish.\u00a0 In this case we will keep the position delta neutral so we sell 460 HD shares short at $29.85.\u00a0 Now the hard part is determining when to adjust the position.\u00a0 Gamma tells us that if the shares move up 1 point our previous delta neutral position is now 46 delta\u2019s long(assuming variables are constant).\u00a0 Selling 46 shares at 30.85 would then re establish a neutral position leaving the position short 506 shares versus long 10 sep. 30 calls.<\/p>\n

After the 1 point rally the stock fades and quickly drops \u00bd point.\u00a0 At this time we buy back 23 shares at 30.35.\u00a0 Later in the day the stock falls back to unchanged and keeping with our desire to stay delta neutral we buy another 23 shares at $29.85.<\/p>\n

The end result we scalped 23 shares making 1 point or $23 and the other scalp was 23 shares for \u00bd point or $11.50 netting a total of $34.50 profit on the stock side.\u00a0 However on the option side the 10 lot position decayed $17 on the day resulting in a profit of $17.50.<\/p>\n

The above example is a very simple example as there are other variables which don\u2019t remain constant in the real world.\u00a0 Also in the example the stock made a fantastic move.\u00a0 One of the hardest choices is determining when to adjust the deltas.\u00a0 Over adjusting say every 25 cents in the above example would have turned a winner day into a loser.\u00a0 Below is adjusting every .25.<\/p>\n

Sold 11 shares $30.10 \u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0bought back 11 $29.85\u00a0\u00a0\u00a0\u00a0\u00a0 net $2.75<\/p>\n

Sold 12 shares $30.35\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 bought back 12 $30.10\u00a0\u00a0\u00a0\u00a0\u00a0 net $3.00<\/p>\n

Sold 11 shares $30.60\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 bought back 11 $30.35\u00a0\u00a0\u00a0\u00a0\u00a0 net $2.75<\/p>\n

Sold 12 shares $30.85\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 bought back 12 $30.60\u00a0\u00a0\u00a0\u00a0\u00a0 net $3.00<\/p>\n

With decay being $17 and buying every .25 move resulted in loss of $5.50(17-11.50).<\/p>\n

One can see how \u201cwhen to adjust\u201d is a key factor in making a move a losing or winning day.\u00a0 Adjusting is an art not a science.\u00a0 We will get into other factors to determine when to adjust but getting back to the example let\u2019s discuss how theta can be affected.\u00a0\u00a0 The decay of an option is not constant.\u00a0 If there are 10 trading days left and the option is trading for $1 it will not decay exactly .10 a day. Weekends create time for something to happen.\u00a0 Assuming no change in volatility an option will decay at a higher rate as it gets 6 weeks closer to expiring.\u00a0 One reason is the odds of the stock moving decreases as the time period decreases.\u00a0 A stock has a better chance to move 5 points over 50 days than it does in 5 days.<\/p>\n

Theta changes if volatility changes.\u00a0 The higher the VOL the higher the price of the option resulting in higher daily decay.\u00a0 Conversely as VOL drops the price of the option declines and so will the daily decay.\u00a0 Besides Theta one should realize not only does one need to trade the gamma in such a way to make the daily decay but a change in VOL will either help or hurt Theta.\u00a0 One can be wrong on the adjustment of deltas on one hand and on the other make it up if VOL pops.\u00a0\u00a0\u00a0 In the case above Vega was .023 meaning a one point increase in VOL will cause the option price to increase 2.3 cents thus creating higher decay.<\/p>\n

Generally back spreads work better on the downside for a few reasons.\u00a0 Stocks decline at a faster rate than they rise. Even though a stock has more upside than downside as a $30 stock can only go down $30 while the upside is theoretically infinite people seem to panic out more than they panic into a stock.\u00a0 Usually a decline in a stock will lead to at least a short term pop in VOL.\u00a0 Stocks rumors can also create a VOL pop but to the upside.<\/p>\n

Overall one can make a lot of money with limited risk using the back spread strategy.\u00a0 Picking the right stock along with the right option is a key to a successful trade.\u00a0 Let\u2019s take a look at real life example I will be trading this week.<\/p>\n

I\u2019m looking for a stock that is between strikes and FCX fits the criteria.\u00a0 Chart wise the stock is expected to move away from this level. It should move into the low 80\u2019s or fall to the 73 level.<\/p>\n

\"\"<\/a><\/p>\n

Here are the stats on FCX- $77.86<\/p>\n

IV30\u00a0 -42\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 IV on the 80 strike is 39 cost $1.15 per contract\u00a0\u00a0\u00a0 Gamma .074\u00a0 Delta- 35<\/p>\n

Theta\u00a0 -.095\u00a0 \u00a0Vega .048\u00a0\u00a0\u00a0\u00a0\u00a0 IV360 \u2013 44\u00a0\u00a0\u00a0 HV360- 50\u00a0\u00a0\u00a0\u00a0 HV10 \u2013 51\u00a0 HV20 \u2013 44<\/p>\n

In example let\u2019s buy 100 September 80 calls for 1.15 costing $11,500 and short (3500) shares at $77.86 (Easy to show using 100 contracts).\u00a0 The 740 gamma will be adjusted every \u00bd point today.\u00a0 At the end of the day will show the stock trades.\u00a0 Depending on the market I might trade for .25 during the slow market hours.\u00a0 Stay-tuned.<\/p>\n

Trading Update<\/p>\n

Wednesday- RESULTS (9\/8\/10)<\/p>\n

Long 100 Sep. 80 calls (cost $11,500)\u00a0\u00a0 $1.15\u00a0\u00a0\u00a0\u00a0\u00a0 Close- $1.46\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Profit\/loss\u00a0\u00a0\u00a0\u00a0 $3100<\/p>\n

Stock\u00a0\u00a0\u00a0 (3500 @ 77.86)\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0$79.14\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 loss\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 (4480)<\/p>\n

Trades-<\/p>\n

SALES\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0BUYS<\/p>\n

(350) $78.35\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0(171.50)<\/p>\n

(350) $78.85\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0(101.50)<\/p>\n

(400) $79.35\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 400 $79.35\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 =<\/p>\n

(400) $79.85\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 284<\/p>\n

200 shares at $79.14\u00a0\u00a0\u00a0\u00a0 delta neutral and of day\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0256<\/span><\/p>\n

<\/span><\/p>\n

<\/span> Total for day\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 (loss $1113)<\/p>\n

Ending delta neutral \u2013 100 sep. 80 calls\/ (4400 shares short)<\/p>\n

Analysis-\u00a0 Vol dropping a point cost the position almost half the loss.\u00a0 The other reason is the manner which we set up the scalping.\u00a0 Half point increments were too wide resulting in few trades.\u00a0 Let\u2019s refine the scalping tomorrow as follows-<\/p>\n

\u00be point first \u00bd hr. of trading<\/p>\n

\u00bd point next hr.<\/p>\n

\u00bc point next 3 hrs. Except limit only 2 buys\/sells (If the stock drops from $79 to $78.75 would buy stock and again at $78.50.\u00a0 If dropped to $78.25 would wait for a \u00bd point lower.\u00a0 Same for the upside-limit sells to two. )
\n\u00bd point last 2 hrs.<\/p>\n

With rates so low the short stock rebate in minimal and won\u2019t be included PNL.<\/p>\n","protected":false},"excerpt":{"rendered":"

The goal of my blog is to teach traders about options.\u00a0 I started trading stock options back in 1985 making markets on the Floor of the CBOE.\u00a0 The changes over the past 25 years in some ways are good while others bad.\u00a0 My views come from looking from the floor outward.\u00a0 Computers have sped up the process but the game … Read More<\/a><\/p>\n","protected":false},"author":143,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1,1378],"tags":[1376],"class_list":["post-6987","post","type-post","status-publish","format-standard","hentry","category-general-comments-2","category-todds-blogs","tag-p","no-post-thumbnail"],"yoast_head":"\nAn "Old" Options Pro Joins The SMB Blog | SMB Training<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.smbtraining.com\/blog\/an-old-options-pro-joins-the-smb-blog\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"An "Old" Options Pro Joins The SMB Blog | SMB Training\" \/>\n<meta property=\"og:description\" content=\"The goal of my blog is to teach traders about options.\u00a0 I started trading stock options back in 1985 making markets on the Floor of the CBOE.\u00a0 The changes over the past 25 years in some ways are good while others bad.\u00a0 My views come from looking from the floor outward.\u00a0 Computers have sped up the process but the game ... 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