New option strategies?


I have two strategies that I use.  I'd like to run these by you for comment.


1.  A biased stock market offers opportunities in ratioed collars.  The stock market tends to drift or steadily move higher but can move lower with great speed.  It tends to go up over time more than it goes down.  How about long the index, short otm calls and long the more otm money puts maybe two to one the short calls so as to be premium neutral.

This idea is fine – to a point.  Most collar traders prefer to take in some cash, but if that's not a concern, it's not a problem.

When you trade as suggested, the puts tend to become worthless as time passes – and offer protection only against a real disaster.  With the 'normal' collar, the put offers better protection (higher strike price).  The rationale for adopting your strategy is the opportuity to own extra puts, thereby giving you the chance to earn a big profit on a severe decline.

From my perspetive, your idea is neither 'better' nor 'worse.'   It's making a choice: 
Do you prefer to own one put that is closer to the money – or two puts, farther OTM – at the same cost?  The former gives better protection most of the time.  The latter sacrifices that 'better protection' for an occasional jackpot.

I find that traders often don't take the time to look at their positions as equivalent to other positiions that are easier to understand.  You want to buy a collar.  But you also want to  embed a 2:1 put backspread.


You trade an index priced at 700 and decide to buy the 680P as part of a collar.  With an IV of 30 and 60 days to expiration, the 680 put costs ~$24.  To find a put priced at ~12, you would have to choose the 645P.  And I'm giving you the benefit of the doubt by assuming that there is no volatility skew and that you can pay the same IV for the 645P as for the 680P.  In reality, you would probably have to buy the 640 put to find one that costs only $12.

How do you feel about owning this position at even money?  I ask because you do own this position when you construct your collar wih two puts per call.

Long 2 Apr 645P

Short 1 Apr 680P

Underlying index is 700; Expiration is in 60 days

The true problem with this strategy is that traders tend to hold positions until the options expire.  With your plan, time is a real enemy and holding to the end is not a good idea.  Here's why:

 If the market really tanks or when IV surges, this spread is a winner – assuming it happens before too much time passes.  If the market moves steadily lower, your 680 put threatens to become a costly short while the 645s fade slowly into oblivion.

That's true of any back spread.  The point I am making is that unless you want to own black swan protection, these back spreads are tricky to manage.  And that is especially true when you are an individual investor paying retail commissions.

I don't like the back spread for practical considerations, although the risk graph is definitely pretty.  You may love it.  That's ok.  Please recognize that your suggested trade is merely tacking this backspread onto your standard collar.  I think you'd be better served if you looked at the total package that way, rather than as 'something special' that you devised. 

 The back spread looks great on any risk graph – when the position is new and there's lots of time before the options expire.  However, as time passes, it begins to look significantly worse.

My bottom line:  This idea is sound if you recognize that you own the backspread plus the collar and that this combination is the position you want to own.


2. How about collecting premium (call credit spreads) to finance a long put position? 

Owning futures (or stocks) can produce an account wipe-out on a big move lower.

Straight long options can kill with time decay.

But short an atm call spread and long an otm put solves both problems as long as commissions and the bid-ask in the options are not too bad.

This is simply one way to take a short position.  Being short the call spread instead of selling anything naked is an excellent way to limit risk.  That's important here because you own the put – a bearish position and are doubling up by selling the call spread.  There is something in your style that likes owning extra options and finding a way to pay for them by taking in cash from a secondary trade.

There is nothing wrong with this idea.  In fact, it's very similar to the 'risk reversal' strategy, in which the trader sells the call (not the spread) and buys the put.  The call sale finances the cost of the put.  I like your idea better becasue it involves buying an OTM put to protect the entire trade from resulting in a gigantic loss.

I find his to be a very reasonable bearish play (obviously this idea can be used for the corresponding bullish play).


No matter which underlying you trade, those wide bid/ask spreads that you mention can be a problem.  One hint:  You never know the true market until entering an order.  I always try to trade near the mid-point of those wide markets – recognizing that I must take the short end of the stick.  That means, paying a bit above the mid when buying and offering below the mid-point when selling.  If I cannot get a 'decent' fill, I find something else to trade.  Index options are actively traded and despite those horrible bid/ask spreads we see on our quote screeds, you should be able to get 'decent' fills when you enter spread orders.

Bottom line: These are reasonable ideas.  You gain something in exchange for something else.  That's always the difficult part about trading.  We want the best of all worlds with our strategy, but it's always a trade-off.  However, here is one compromise:  Do a 'regular' collar, collecting a cash credit.  Use that cash to buy some OTM puts.  You own far fewer puts, but you have better protection.  Just a thought.


The December 2010 issue of Expiring Monthly will be published today.

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18 Responses to New option strategies?

  1. rick f 12/20/2010 at 6:57 AM #

    Hi Mark:
    In response to point 2, where you said: “Owning futures (or stocks) can produce an account wipe-out on a big move lower.”
    I agree completely.
    When I first read that, I flashed back to my early days of options trading where family members would flail their arms and blithly say “oooh, bad boy — options are dangerous!”
    Obviously ANY trading tool can be dangerous and cost you an account (or more!) if you don’t know what you’re doing.
    However, I don’t mean to nitpick, but I respectfully submit that adding the phrase “without proper risk management or controls” would make that statement a bit more accurate.
    Yes, I know you know that … perhaps I’m being overly pedantic before my morning coffee hits me. For that, I apologise.
    Anyway, Happy Holidays to you, your family and all the fine folks reading this blog and/or subscribe to EM.

  2. Mark Wolfinger 12/20/2010 at 8:10 AM #

    Good morning Rick,
    Point 2 was the my correspondent’s quote. I did not mean to publish in in bold.
    But I agree that using futures or long stock as an investment, or to adjust position delta is far riskier than it appears. It’s essentially the same as selling a call with a zero strike price. In turn, that is done to avoid paying time premium to own options. A bit short-sighted, in my opinion.
    So, bottom line is that I agree that there are option strategies that are preferable to owning the underlying.
    Thanks for the good wishes. I wish you the same.

  3. sandeep 12/20/2010 at 8:17 PM #

    Hello Mark,
    Regarding your hint about entering orders and trying to trade near the mid-point, I wonder if you could offer any guidance for trading the indices such as SPX or RUT. I am very familiar with trading SPY with it’s penny wide spreads and excellent liquidity. I have recently tried trading SPX, which has very wide spreads and only trades on one exchange. I have had mixed results – on one occasion a calendar spread was filled quickly at the midprice, on another a similar trade sat at the midprice an entire day and then expired. I am aware of some basic guidelines for trying to enter trades in this kind of situation, like perhaps testing the market with a single contract at the mid, maybe adjusting the price by a small amount if it doesn’t fill. The problem is with spreads that wide I don’t have a good sense how far off the mid is “reasonable”, what kind of increment I should use when I adjust my bid or offer, and when one should just walk away. Also, in trading SPY, even if you just take the natural on a multi-leg position you get a somewhat reasonable fill. I can only imagine how badly that might go on SPX. Of course the reason I’m trading SPX is because of the savings in commissions and tax advantages – I’m hoping that all those advantages are not negated by the wide spreads and seemingly difficult executions. Any advice you might have would be appreciated.

  4. Mark Wolfinger 12/20/2010 at 11:15 PM #

    Hello s,
    There is no substitute for seeing how it works. To me that gives you three choices
    1) Stay with SPY. Pay extra commissions and taxes on profits.
    2) Try SPX in a paper-trading account – but only if your broker promises that the fills are realistic. TOS gives fills that are unrealistically good. Other brokers have paper accounts that are disgusting: If you do not pay offer and sell bid, you get no fills. Those are worthless.
    I don’t know which broker offers a realistic paper account.
    Can anyone help?
    3) Try it with real money. Enter trades at 5 cents worse than mid-point and see what happens. Do it for at last one week. See if you get fills. However, if you get a fill because the market moved against the trade, do not count that as a ‘5-cent away’ fill.
    When you have done that for awhile, go to 10-cents.
    Then 15-cents. Stop when you no longer want to accept the trade at the price.
    If you get the fills you want – consistently, then you have a good answer. If you don’t, then you have another answer.
    4) Warning. When MMs want to take the other side, they will pay higher. When they don’t they will pay less. Thus, the experiment I described is going to be flawed by market conditions and MM positions.
    I have no good information for you. Except this: Do not trade a single contract. The fill will not be favorable and you will have a tough time finishing the spread.

  5. sandeep 12/23/2010 at 8:57 AM #

    SPX is a strange bird. As I mentioned before, I have had spread orders that have sat at the mid all day and then expired. This morning I placed an order to sell a calendar for 25 cents above the mid, and it fills in 2 seconds. I can see it’s going to take awhile to figure out how this thing works.

  6. sandeep 12/23/2010 at 9:34 AM #

    Here is another problem I have with SPX. This morning I place an order to buy a Jan butterfly at the mid $1.35 – thinking that the mid would probably be a reasonable fill. It sits there for 30 minutes, now all of a sudden the mid is 0$.85 and the natural is $5.00, and the market has done almost nothing. I find it hard to believe that these CBOE market makers are creating efficient markets with this product – back to SPY for me.

  7. sandeep 12/23/2010 at 9:42 AM #

    Don’t mean to beat a dead horse so this will be my last post on the subject – but I think it is informative. Now two minutes later and the market has done absolutely nothing, the mid has jumped from $0.85 to $1.85, the natural has gone from $5 to $7. This is just the Jan 1250/1265/1280 butterfly, so it’s not like we’re looking at options that should be thinly traded.

  8. Mark Wolfinger 12/23/2010 at 11:38 AM #

    When you determine the ‘mid’ how do you do it?
    Do you use a quote for the spread or for each individual option?

  9. Mark Wolfinger 12/23/2010 at 11:42 AM #

    No one said the markets are efficient. With no competition, they trade when they want to do so. When you place an order, such as a butterfly, there is no chance that there will be an individual who will take the other side. It’s the market makers or no one.
    If you prefer SPY, then trade SPY. I also avoid trading SPX

  10. sandeep 12/23/2010 at 11:45 AM #

    Hi Mark,
    I use thinkorswim, so when the trade is placed their software places it at the mid by default. I believe they just take the mid for each individual option, and then use those prices to calculate the mid quote for the spread. The prices I was quoting were the mid for the spread.

  11. Mark Wolfinger 12/23/2010 at 11:46 AM #

    All you are seeing is that the bid/ask spreads are changing from wide to wider.
    No one is actively quoting the spread that you want to trade. And you forget the obvious: Sometimes there is a customer order – for one contract – that temporarily tightens the bid/ask spread. It also affects the ‘mid.’
    For you, SPY is better, safer, and more easily understood.

  12. sandeep 12/23/2010 at 11:50 AM #

    Hello Mark,
    Yes, I agree so I went ahead and placed that butterfly on SPY and got filled at the mid in about 5 minutes. It is just disappointing, I now have 40 contracts instead of 4, and no tax advantage. I just expected tight markets and lots of liquidity in something like SPX – live and learn.

  13. Mark Wolfinger 12/23/2010 at 11:51 AM #

    It is absolutely idiotic to allow a broker to determine at what price you want to trade.
    This is not a broker who gives trading advice. By establishing the mid point as the default bid or offer, they would be giving advice.
    I suspect that they show you the midpoint so that you have an idea of what to bid. It is not intended as a suggested price to bid.
    And the point of my question was this: If you don’t check the true (eliminate the small-sized orders when you see them as the bid or ask) then you have no idea of the true mid. And as mentioned, that’s why the mid can change so drastically.

  14. sandeep 12/23/2010 at 12:12 PM #

    Yes, I understand why tos defaults to the mid and that it is there to give you an idea of what to bid, not a recommendation by them. In a very liquid underlying with tight spreads, that mid will usually be a fairly reasonable price to place the trade – SPY is a perfect example, but there are many others, look at IBM, WMT – at any given time that you decide to implement a trade, either a single option, calendar, butterfly, whatever, placing the an order at the mid will give you a order with a decent chance of filling at a reasonable price. Not so with SPX – and I am surprised by that because I would have expected that an underlying that lends itself so naturally for trading would be much more liquid and have much tighter spreads, even if it is only traded on one exchange.

  15. Mark Wolfinger 12/23/2010 at 1:49 PM #

    You got filed at the mid? Why did you chooe the mid?
    You wanted to pay $1.35 using SPX options. What did you pay for he SPY butterfly?
    It it was more than $0.135 you paid too much.

  16. Mark Wolfinger 12/23/2010 at 1:51 PM #

    When you enter an order with THREE legs, you miss out on essentially ALL of the liquidity.

  17. sandeep 12/23/2010 at 4:02 PM #

    I chose the mid because I wanted to
    give myself a good chance to get into the trade. The spreads on the individual options were all penny-wide, and the difference between the mid
    and the natural was 3 cents. I watched the action on the prices for a few minutes (during which time the mid would occasionally change by a penny), and then placed my order which eventually filled. I have bid a penny or two below the mid on spreads with SPY in the past, sometimes they have filled, sometimes not, so I chose the mid this time to give myself a good chance to fill but at a better price than the natural.
    I didn’t do the same butterfly on SPY as I was planning on SPX, but I see your point. Next
    time I want to make a trade on the S&P I’m going to use SPY to help determine a reasonable price
    for the trade, then convert that to SPX and see if it is in the ballpark. Not holding my breath though, with 10x multiplier on the couple of
    penny wide SPY spreads you get spreads of maybe
    30-40 cents on SPX, which would be a lot better than the $1-2 dollar spreads I am seeing even
    when looking at the bid/asks with the bigger order volumes.

  18. Mark Wolfinger 12/23/2010 at 7:33 PM #

    Thanks for explanation.