Three Questions from a Reader

1. What’s your strategy on buying LEAPs options? In order to avoid time decay, when do you roll out if you have a long term view and would like to hold on the securities as long term investment? I guest the pros probably do it within at least 6 months of remaining time value?

    I do not buy LEAPS or any other options.

    If I were to buy LEAPS calls, I would buy options that are in the money — but ONLY on a stock that I want to own because I anticipate that the stock price will move higher.

    When buying any option, “worrying” about time decay is important – but it is not your primary consideration. And when buying LEAPS options IMPLIED VOLATILITY (IV) is far more important than time decay. I know that you are new to options, but please take this statement as true: When you pay too much for the options, your chances of making money on the trade are reduced significantly. It is a very bad idea to buy LEAPS options when IV is relatively high. To get more information on IV, read this article and follow the links.

    When you have a long-term view and when you know that you plan to own the options for a long time, then you want to buy an options with less time value (rather than one with more time value). That means owning an option that is even deeper in the money. In this example, I would buy the Jan 2016 70 call with no plan to roll until expiration is nigh (unless I roll to a higher strike price, per the discussion below).

    I would roll ONLY when two conditions are met:
    I still want to own call options on this stock (as you probably do). But sometimes, you must be willing to accept the fact that this stock is not going to move higher and that you made a mistake buying the call options in the first place. Do not make the mistake of rolling just to get more time.
    Also: IV cannot be too high or else you are paying far too much for your new call option.

    When would I roll? When I have a nice profit to protect. For example, let’s assume that you buy a call option on stock XYZ whose current price is $80 per share. The LEAPS call expires in Jan 2016. I would buy the call with a strike price of $75 (In the money). If the stock rallies (assume it goes to $92) and if I believe that the stock will move still higher, I would sell my Jan 2016 75 call and buy the Jan 2017 85 call or the Jan 2016 85 call. The decision would be based on how much time remains before Jan 2016 arrives and whether I prefer to own a 2016 or 2017 call. NOTE: The Jan 90 call is not sufficiently in the money and is not a good choice for the person who plans to hold onto the option for a long time.

2. When you sell put/call options, do you sell for a 1-month expiry options or longer so that the premium is higher but takes longer for the option value to decay due to longer time frame?

I do both, depending on the situation. My recommendation for you – as a newer trader – is to write options that expire in about 60 days. That is a good compromise between less risk (shorter-term options come with little protection against a loss) and the less rapid time decay.

3. As my portfolio is small and $10k, like most rookie traders, I am comfortable with selling 1 or at most 2 covered contracts of puts/calls options. But the premiums is very little for a forward 1 month expiry options. This prompted lots of newbies, to take unusual large risky position on selling naked puts like 10 contracts which can be disastrous when volatility increased. What’s your take on this?

***If the premium is too small and if it does not allow you to make a satisfactory profit (THINK IN TERMS OF PERCENTAGE PROFIT, NOT ON TOTAL DOLLARS PROFIT) then you have chosen an inappropriate call/put option to sell. Find another stock or better yet, choose a longer term option. DO NOT increase position size just for the chance to earn more money. This is a risk that no trader can afford to take.

You may even have to find a broker who charges lower commissions, but please, never increase risk just because the potentials gains are too small. The only time to increase risk (and that would be going from 2 options to 3; never from 2 to 10) is when you deem the trade to be extremely attractive.

2 Responses to Three Questions from a Reader

  1. Desmond 03/18/2015 at 9:23 PM #

    Thanks Mark for the detailed explanation and they cleared my doubts. I have a better perspective on buying a LEAPS. Generally, it’s better to buy a Deep ITM option to have lower IV, as IV is relatively higher at ATM option. I read the link given on IV. From my experience, it tells me that sometimes it takes days/weeks before bid/ask comes to an equilibrium. Hence, newbie like me always buy at a high IV which is difficult to make money.

    You can increase the odds of success by a large amount (you will still have to get the direction of the stock right) by simply buying spreads, rather than single options. Sure, it limits profits, but you will make money far more often. Continue to buy ITM options, but you can sell one option for each one bought. Sell ATM or slightly OTM.

    And if you are willing to increase the chances of success by even more — along with reducing the profit potential — you can sell OTM put spreads instead of buying call spreads.

    It pays for you to understand the concept of how/why some positions are equivalent to others. Not for this trade, but to better your undertanding of options.

  2. Antonio 03/26/2015 at 2:07 PM #

    Dear Mark,

    Firstly hope everything is OK as you dont´write too frequently in the blog.

    May be you remember me because throughout the years I have done some questions and also was in the premium forum a few months. I got out because it coincided with a strong work time and also left trading because of the poor results.

    I came back to the idea of ​​the Iron Condor and re-reading some post I would like you to validate this system and give me your opinion about it.

    The idea is to close by stages as you suggest and I expose the numbers.

    In thesee low volatility time seems to make an IC by 3$ is very difficult. 2.5$ could be easier with delta 15 ~

    IC 3 months.

    Closing the not closed spread 3 weeks before exp spread (estimated a value of 0.5)

    2.5 x 6 IC = 1500.

    1 # adjustement Close 20% position. losing $ 100 (1 contracts) = 100 (close threatened spread only)
    2 # adj. close 30% position. losing $ 150 (2 contracts) = 300
    3 # adj. close 50% position. losing $ 250 (3 contracts) = 750

    Let’s get the bad (not sure if enought) and think we would have to adjust 6 months 6 months 3 times and 2 times closing the spread attack

    3 settings:
    1500-100-300-750-300 (spread value not threatened 0.5×6) – 60 (comission) = $ -10

    2 settings:
    1500-100-300-300 (spread value not threatened 0.5×6) – 60 (comission) = + $ 740

    -10×6 Months = -60
    + 740×6 months = 4560 ….. ….. 4500$ year …. Total Annual Performance = 4500/18000 = 25%

    As I say I’d appreciate an opinion as deep as possible, because regardless of other possible adjustments we can make, I think the way you handle the IC goes here.

    Honestly I pulled away from trading because not getting results but I continue thinking IC are great and that your way is one of the best to do it.

    I have seen that the forum is out thought giving some compensation for your opinions, to some way of pay you my questions passed, present and future, as I would if possible to create a system with IC as objective as possible and similar to yours. Please tell me if there is some way to compensate for your opinions¡¡

    Grateful

    Antonio

    Reply in full blog post: http://blog.mdwoptions.com/options_for_rookies/adjusting-in-stages-the-reality/