Elite Trader Forum

Mea Culpa.  As pointed out by Wayne of Sigma Options, I erred.  His comment is below and this post was updated Jun 9, 12:40 PM.

Elite Trader attracts a variety of posters to their forums.  Some are rookies, some are very experienced, some are professional traders, and unfortunately there are always those who try to spoil things for everyone else. But it is a worthwhile place to visit.

Here's a recent question that resulted in a bit of difficulty for the person who asked the question:

"Selling ITM strangles is equivalent to selling OTM strangles with the same strike prices: True or Not?  Why?"

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Here's my attempt to solve the problem.  I thought it may be of interest to readers of this blog.

Example:  Assume SPX is 900

ITM strangle:
  

Sell SPX Jan 850 call;   Sell SPX  Jan 950 put

OTM strangle:

Sell SPX Jan 950 call;   Sell SPX Jan 850 Put

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You are having a problem comparing these positions. Try this:

Consider the difference between the two strangles. To do that,subtract one strangle from the other.  For example, Add the legs from the ITM strangle and subtract the legs from the OTM strangle,

Take the four legs from both strangles.
Add them to make a single position.

Theat position is now a long box.

Long Jan 850 Call
Short Jan 950 Call

Long Jan 950 Put
Short Jan 850 Put



A box is a riskless (ok, there is pin risk) position that varies very
slightly in price as time passes (or interest rates change) due to the cost
of carrying the position to expiration.

Next, break that box into a call spread and a put spread, instead of two strangles.  That gives you the SPX Jan 850/950 call spread and the SPX Jan 850/950 put spread.

It's easy to see that at expiration, no matter what the price of the
underlying, the call spread plus put spread equals the distance between
the strikes, or 100 in this example. Thus, the price of the box is constant.

If the value of the box is constant, that means the difference between the two strangles is also constant  the value
of the box
because that difference is a box spread.

Sell either strangle – and the P/L must be identical.  Why? Because the difference between the strangles remains constant.  If one strangle declines in value by $5,000 then the other must also lose $5,000 of value.

This assumes you
collect the value of the box as the extra premium when selling the ITM
strangle.  In other words, you should collect almost $10,000 extra (fair value is $10,000 less interest through expiration) when selling the ITM strangle when compared with the OTM strangle. When expiration arrives and you are assigned one or two exercise notices on your short options, you will repay that extra $10,000 if you sold the ITM strangle.

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10 Responses to Elite Trader Forum

  1. Jimmy J. 07/09/2009 at 9:39 AM #

    What is the best way to determine the intermediate trend of and optionable security?? I’ve read about more technical indicators than I can remember and while some seem logical, it seems a nearly impossible task for a novice to put together a winning trend following system. There seems to be an infinite number of possiblities. It seems to me that once I have a good idea of how to determine the trend of a security I can apply the principles in your book and come up with a winning combination. Are there particular indicators you use? Any other recommendations? I would appreciate any help that you might be able to offer. Thank you!

  2. Mark Wolfinger 07/09/2009 at 10:38 AM #

    Jimmy,
    I’m sorry, I cannot help.
    I use no technical indicators. I do not try to follow a trend. I never pick market direction.
    I never learned about any of those ideas, so cannot send you in the right direction for additional information. Sorry.

  3. Sigma Options 07/09/2009 at 11:50 AM #

    Hi Mark,
    Forgive me if I’ve read this wrong. I love your comparison using synthetics, great stuff. But to create a box one would have to buy one of the straddles and sell the other… I’m sure that’s what you meant.
    The last paragraph might be also be confusing to some as it seems to unintentionally contradict the preceding paragraphs. Yes, the ITM strangle collects 10k more, but there is the cash settlement of the options at expiry which takes that additional 10k, making both sold spreads equivalent.
    Cheers
    Wayne

  4. Mark Wolfinger 07/09/2009 at 12:41 PM #

    This question arose when someone questioned whether selling one straddle was really equivalent to selling the other.
    You are not wrong. I have updated the post, giving you credit for finding the error.
    Thank you.

  5. Dave 07/09/2009 at 2:21 PM #

    I think I can help Jimmy J concerning market direction…
    First I’d recommend getting yourself a decent crystal ball. Next, step back 12 feet and toss a dart at a board you’ve labeled with 50/ 50% bull & bear targets. Depending on where the dart lands– immediately research a related (bull/ bear) blog– I promise you’ll be genuinely and absolutely amazed at the intelligent directional conviction to be found.
    Mark- This blog is a bright & shining beacon of sensibility amidst a sea of danger, thank you for the effort you spend on it!

  6. Mark Wolfinger 07/09/2009 at 3:00 PM #

    What size should the dart board be?
    Thank you Dave

  7. Dave 07/09/2009 at 4:28 PM #

    Board size isn’t important but i do recommend Velcro darts– depending on result of proceedure having a sharp object present may not be in your best interest.
    And no regrets here btw. Sure there was the 90 hour work weeks one after the other, year after year after year. But the knowledge I obtained through almost 22 years years(!) of technical study made it all worthwhile… Yep, the day it finally dawned on me, that I, could not personally predict the future (or like you say; “didn’t have those skills) was truly an electrifying epiphany, a once in a lifetime.
    Now I whittle away most of my time with what family I still have left or know– and just let the greeks do their stuff.
    Do I miss the sleepless nights? The thrill of the chase and the raw magic of blowing up an account? Is it possible I was really on the verge of technical enlightenment, and quit just hours too soon?

  8. 414maple 07/09/2009 at 11:42 PM #

    It was that same post on Elite Trader that led me to subscribe to the feed here.
    Thank you Mark and Dave for the humorous insights.

  9. Mark Wolfinger 07/10/2009 at 7:43 AM #

    I love Dave’s humor also. Hope he sticks around!