Options for Rookies

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67 Responses to Options for Rookies

  1. Daniel 10/17/2009 at 7:57 AM #

    Hi
    What would you think of an unbalanced fly (aka BWB)as an adjustment to a credit spread under pressure (i.e. underlying moving faster than anticipated towards the short leg of the spread)?
    TIA

  2. Mark Wolfinger 10/17/2009 at 4:25 PM #

    Doesn’t the BWB add to your losses if the market continues in the same direction?
    Csn you provide an example? To me, the BWB is the buy the butterflyL
    Buy A
    Sell 2B
    Buy C
    Where c is further from B; than A is from B

  3. Daniel 10/18/2009 at 5:07 PM #

    let’s take Oct expiration cycle. I had an SPX call credit spread 1100X1110. When the market touched 1080 I would “buy” the 1090X1100X1120 BWB for credit.
    thanks for your reply

  4. Mark Wolfinger 10/18/2009 at 10:23 PM #

    Danierl,
    Good topic for discussion.
    Can you really get a credit near expiration? I’ll take your word for it that you can.
    When you combine the original credit spread with the new BWB, you get two positions:
    a) 1090/1100/1110 long butterfly. If the market moves higher, towards 1110, your butterfly loses value – and above 110 is worthless (at expiration). But, you do have the potential to earn extra profit above 1090 and below 1100.
    b) 1100/1120 short call spread. This offers more risk than your original 1100/1110 spread.
    In sum, I don’t like the trade – from my perspective. I have no quibble if you like it from yours.
    You do get the positive return in the 1090/1100 area, but wasn’t this trade made as an adjustment to being short the 1100/1110 spread?
    Obviously the adjustment must fit your perception of risk. But you still do not solve the > 1100 probelm, unless the finish is just a little bit above 1100.
    Yo do have a better profit zone, but your 10 point upside risk has become 20 points. That does not feel like an adjustment to me. But it does depend on how you look at it. You get a higher probability of earning a profit, but the ultimate risk of loss is higher.
    I understand how this may work for you – and encourage you to take a closer look to be certain it does work for you. But it doesn’t work for me. I worry too much about the potential larger loss.

  5. Donald W. 10/23/2009 at 9:33 AM #

    MARK,
    I would much enjoy your webinar but will have to be out to sea and my connection is very slow, just wondering are you planning on recording it and putting it on your web page.

  6. Mark Wolfinger 10/23/2009 at 9:44 AM #

    The webinar will be archived and avialable.
    I don’t know if I will be allowed to post it on my page, but I’ll add a link to TradeKing’s site – where it will be available at no cost.

  7. Donald W. 10/30/2009 at 11:54 PM #

    Mark,
    I was wondering what you thought of Steve Smith article at Minyanville basically blasting covered calls and recommending instead the following two technique:
    quote ”
    Replace the underlying long stock with the purchase of an in-the-money LEAP, or long-term call option.
    Rather then selling a single strike call, short sell a vertical spread short for a credit
    “Unquote
    After reading your book on Creating Your own Hedge Fund. I certainly will be sticking with your recommendation. Nothing like getting an instant discount, especially when I have no ambitious to sell the ETF once purchase. Looking forward to studying it more in depth and just order your other book on Options for Rookies, hope to enjoy it equally as well.

  8. Mark Wolfinger 10/31/2009 at 9:35 AM #

    Such a good question. Yo have essentially given me a homwork assignment to reply…in a separate post.

  9. Chris-O 11/02/2009 at 5:02 PM #

    Mark,
    I enjoy your teachings. My first Q. here.
    I see some people in the Dutch sector of the world market advise a diagonal spread. But they choose a massive time effect on the long leg.
    Underlying is a stock with proper stable cashflows, former state telecoms (KPN). It has been remarkably resilient in the markets great upheaval of the last year.
    SELL MAR-2010 12EURO – BUY DEC-2013 10EURO at price of underlying 11 EURO, advice dated half september-2009 or so.
    It is not really about the specific underlying, Generally: Doesn’t the extremely extended duration of the sold leg expose one to a large volatility effect, when VEGA goes down? I appreciate they’re trying to spare time loss on the long leg but….?
    Second, the greek “rho” is seldom discussed as it is not very influential. NORMALLY. But intrest rates are excessively low and are bound to go up quite massively I think to entice non US savers to suport the US deficit.
    Do I now need more knowledge on “rho”, certainly in the light of massively long duration legs discussed above? I don’t quite understand the RHO effect on options other than it has more effect on longer time scales.
    I am thinking of entering a longterm covered call on SHELL for 6%pa dividend + 5%pa on a written 2013 call.
    Thanks in advance,
    Best Regards,
    Chris-O
    Holland
    P.S. I use Peter Hoadleys toolset to play around with greeks volatility, etc.. its how I came up with the rho thing.

  10. Mark Wolfinger 11/03/2009 at 8:33 AM #

    Welcome Chris-O
    Yes, the EXTREME length of time in the BOUGHT (not SOLD) option is essentiall the risk in this position. It’s so large that it minimizes the effects of a price change in the underlying.
    Perhaps this was done intentionally because the person who suggested this idea believes the IV is very low and this is a good time to own vega. But, unless that is true, this is a risky position.
    Rho is especially ignored now – when interest rates are low. In fact, rho is only important when trading longer-term options. But interest rates will rise again one day. Rho will seldom, if ever, be an ‘important’ factor when trading short-term options, but when rates are higher, it will not be ignored.
    One reason for buying very long-term options is that they will rise when interest moves significantly higher. That may be another consideration on the part of the buyer of those 2013 calls.
    If you write that very long-term call, you understand that IV may increase. If you believe interest rates are also going to rise, then you will miss out on collecting a higher price for your long-term option.
    There are really only a small number reasonable choices:
    a) Trade now, and if you are happy with the premium collected, don’t be concerned with whether the option price moves higher. This is a simple choice, but I don’t think it’s correct for you because you understand the finer points.
    b) Settle for a shorter-term option now (perhaps 6 to 12 months), as you wait for interest rates to rise. That’s assuming you believe they will rise soon. There is no point in waiting for a couple of years.
    Obviously a stock price decline will not be good, but I assume you arae not bearish or you would not be writing a covered call.
    c) Base your decision on implied volatility. Any time you believe it’s high enough, make the trade.
    Hoadly has great software at a reasonable price ($100 USD). I’ve never used it, but have seen it in action.

  11. Chris-O 11/03/2009 at 4:01 PM #

    Thank you Mark,
    Some things have become more clear. I’m not sure I do get the finer points. Technically perhaps, if I study. But I have to work on certain personal tendencies. Restrain the need to act mostly, to do the big thing straight away. Having an intermediate option for some length of the timeframe to see what intrest does had not occured to me. Does give me less insurance because of lesser premium. So for now I’ll postpone this action as I am not sure I am still bearish on SHELL. Burnt my hair a bit lately trying to do really directionally intendended things.
    Thank You, Best Regards,
    Chris-O

  12. Mark Wolfinger 11/03/2009 at 8:25 PM #

    Yes, selling shorter term option does give you less insurance.
    “I am not sure I am still bearish on SHELL” Writing a covered call is not a good idea when bearish. This stratgy does best when the stock rises.

  13. terry@terryorourke.com 11/05/2009 at 7:06 PM #

    Hi Mark,
    I have been reading this blog for a while and decided to ask a question.
    I have been out of option trading for a while and have decide to come back to it. You have been mentioning that today it’s really important to hedge risk and I totally agree; that’s one reason I’ve bee out; I hadn’t really figured out a comfortable way for me to do that. One stratagy I have been considering and now testing in my paper desk is to sell covered calls for premimum and delta balance the buy/write and then hedge that buy/write with with a long ATM put 6 or 7 months out. My thoughts are that the put will protect me against big opening gaps while costing me less theta than the premium earned by the short call.
    Any thoughts?
    Terry

  14. Mark Wolfinger 11/05/2009 at 7:35 PM #

    This Q & A will be a blog post, Nov 6, 2009
    at 9 AM Central Time

  15. jeff partlow 11/07/2009 at 7:49 AM #

    Mark,
    Just read your article in Nov. ‘Futures and Options’. Very well done! Perhaps there is hope that you will evolve into a fellow Covered Calls Investor?
    Regards,
    Jeff

  16. Mark Wolfinger 11/07/2009 at 8:37 AM #

    H Jeff,
    I have nothing aginst writingcovered calls. That was my maor strategy for many years. Today I’m more consevative and prefer the collar, or it’s equivaent.

  17. terry@terryorourke.com 11/08/2009 at 10:31 AM #

    Hi Mark,
    Thanks for the reply on my question of covered calls (collars) and delta hedging with 6 month out puts. Your point is well taken on the IV (vega) of the 6 month out puts and the suggestion of 3 months out is more practical. (https://blog.mdwoptions.com/options_for_rookies/overwriting-a-collar/)
    What intrigues me about this strategy is delta balancing a position like this and harvesting theta. In my previous experiences with delta balancing positions I always bought and sold the stock rather than the options because the size required can be less than 100 shares.
    Is there another strategy that gives similar risk exposure and allows one to harvest theta? I don’t necessarily want to set up a position and forget it but I don’t want to create situations that require complex multi leg balancing either.
    I find that keeping things simple works for me. . . . but too simple in times like these can also be risky.
    Again thanks,
    Terry

  18. Mark Wolfinger 11/08/2009 at 11:01 AM #

    I’m not suggesting 6-month puts is a bad idea. Just want to be certain you recognize times when it may not be so good.
    Harvesting theta is great fun. But you also harvest negative gamma, and that makes it a situation with increased risk as well as increased reward. if you want that position, there is nothing wrong with it.
    Just keep in mind that theta is not there to be collected as a gift to you. It involves risk.
    Yes, delta scalping with 30 delta can be a bit awkward, but you can sell one call or put instead of stock.
    Simple is good. I like simple.
    The only way to get positive theta is to sell options or option spreads. Thus, I don’t have a list of strategies to give you.
    I suggest you look at selling put and or call spreads (if you do both at the same time, it’s an iron condor).
    I do NOT recommend selling straddles and/or strangles. Selling naked options can work, but I don’t like the risk involved. Selling spreads is better.
    It’s not that ‘too simple’ is risky. The real risky part is selling extra options. It cuts reward significantly, but I prefer buying one option for every option sold. That suits my comfort zone. I cannot speak for yours.

  19. Joel 11/09/2009 at 7:25 PM #

    Hello Mark:
    I am awaiting your book, but I have read other authors, and I want to use a “Deep ITM” option
    to buy and control a stock, XYZ, a blue-chip company. This to control the stock at less cost
    than buying outright, while taking advantage of a near to 100% delta relation between shares and option.
    My intention is to sell a Covered Call against the shares, just above ATM, with the intent of
    assigning my shares (those for which I do not yet own, but hold an option) if the holder of my
    sold option exercises his option. I want to collect the difference in my option strike price and present
    price of the shares for my account, rather than just exercise my option to close the Call I wrote.
    Another goal is to own the right to buy my shares at a future time, at today’s price, when I will have
    more cash on hand. If my Covered Call is assigned, I am delighted. I will wait for another dip
    in the share price to buy another “DITM” option as above, as I want to own XYZ stock when the price
    is right.
    For the short time I “pass-on” my assignment I would prefer not to have cash on hand.
    I am sure this can be done, can you help me with the mechanics.
    Thanks-Joel

  20. Mark Wolfinger 11/09/2009 at 7:46 PM #

    Joel,
    I’ll reply as a separate blog post on Wed, Nov 11, 2009

  21. test 11/16/2009 at 2:35 PM #

    test reply to Mark…. can you “see” me?

  22. Mark Wolfinger 11/16/2009 at 3:09 PM #

    Yes, I see you.

  23. formerlythere@gmail.com 11/17/2009 at 8:21 AM #

    Since you ran away from the discussion, I thought I’d bring the discussion back to you. To wit:
    Mark, you crack me up. You accuse. You taunt. You boast. But when it gets thrown back in your face, you cower like a coward. (And for the record, only half of what you cited as Larry’s retorts actually came from Larry; the other half came from me. Proper attribution is another point to consider when it comes to avoiding lawsuits.)
    For disclosure’s sake, I am a passive investor from the same camp as Larry. Our firm manages around 60 clients, and yes, Mark, as hard as it may be for you to grasp, a vast majority of them are happy following (or perhaps still amidst) this bear market. Why? Because they followed academically-based investment theory, stuck to that strategy even in tough times, and are now reaping the rewards.
    Did a computer tell me, or my clients, how they should invest? No. Academic research did. This is the gist that you fail to grasp. To call Modern Portfolio Theory and asset allocation outdated — particularly at a time when they are showing how valuable they are — just exposes your personal bias.
    Which is fine. Every man is entitled to his bias. That’s your decision and I do not chide you for sticking to your guns. Personally, I’m more offended by your spelling and your grammar than your investment philosophy.

  24. Mark Wolfinger 11/17/2009 at 9:32 AM #

    1) Always happy to provide a laugh.
    2) I don’t believe I ran away from the discussion. This was obviously a disagreement with no end in sight.
    3) Boast? Show me one quote in which I boasted. Just one. If you want to have a discussion, let’s keep it honest.
    4) I apologize if I did not recognize that the comments came from you, and right now, I don’t know who you are. I suppose I should have been more careful in determining who wrote the comment to which I replied.
    5) My point is that academically-based investment theory, like all theories, can change over time. If (and I say if), the efficient market theory is shaken or disproven, then a new theory will be devised. I accept the fact that this is the theory followed by most. I even wrote favorably about Modern Portfolio Theory in my 2005 book.
    Bu I am no longer a believer. I believe the evidence to support the theory has been shaken. I believe that globalization and the modern world are different. No solid proof yet, but I see too much correlation in assets that – at one time – were far less correlated. The 2008 bear market showed me that correlation was higher than anticipated.
    That’s not proof. And investors who owned bonds as their allocation method of choice fared far better than those who chose real estate or foreign stocks. Time will tell if MPT and the efficient market model survive. For now, for me, I recommend using collars to guarantee that your assets don’t get clobbered. You can continue to use your academic-based methods.
    6) Please note: I never said your methods are bad. I believe they are outdated and far less efficient than adherents claim them to be.
    7) Reaping the rewards. That’s the part that’s so funny. If you and your clients hadn’t been battered so badly last year, there would be no need to reap rewards to recover.
    Investors who protected portfolios with options would have lost far less, returned to where they had been more quickly, and yes, made less since March of this year. But I believe they would be ahead of where you are – and that’s sans knowing just how well or poorly your clients fared. I have no clients, and cannot make real world comparisons.
    I am not suggesting 100% collars, nor am I saying allocating assets has no value. It just has less value that it did at one time. It’s not as effective today as in the past.
    8) The spelling and grammar are the result of a faulty computer keyboard – when typing into certain fields. In fact, I’m forced to write this response in Microsoft Word and then transfer it to the reply section – simply because about 20% of the keystrokes are not accepted. I have no idea why that’s true, but it’s a recent phenomenon. I apologize if I failed to correct all errors.
    9) When you say that academic research suggested how to invest, I would appreciate an answer to the question: Did the specific trades made for clients come directly from you, or did you use a computer to generate a portfolio – based on that research? This is a curiosity question.
    10) Thanks for continuing the dicussion

  25. Dimitris 11/19/2009 at 6:10 AM #

    Mark,
    I am not a very experienced trader and currently trade SPY iron condors. Every week, I read TA reports from Larry McMillan and S&P, so I think I have a rough idea about the possible directions (support and resistance) of the market until next expiration day (I allow enough margin for safety on these ideas). Based on that, I try to establish one new position, for the front month, roughly once a week (but not in the last 6-10 days before expiration).
    However, I find that trying to establish a “safe” IC position, reasonably OTM, many times, I can not get a “good” premium for both the call and the put leg. Therefore, my question is whether it is a better idea NOT to establish both legs of the IC on the same day, but one leg today and the other a few days later, depending on the move of SPY. If SPY moves in one direction only (rather unusual) then I will accept that my portfolio will only have some “good” call (or put) credit spreads and no iron condors for this month, which is not a big problem. What do you think?
    Thank you

  26. Mark Wolfinger 11/19/2009 at 8:13 AM #

    Very good question – worthy of a separate post. It will appear tomorrow.
    Quick reply: Cannot get satisfatory premium and ‘safe’ so near to expiration.

  27. Donald W. 11/22/2009 at 9:47 AM #

    Mark,
    Just receive your book on Rookies guide to options and loving it. Starting to make some spreadsheets by downloading options into it and using your Tables as examples. This is a dream come true for me to be able to understand and use options with RISK management like the professionals and all for less then 30 dollars. Thank you very much.

  28. Mark Wolfinger 11/22/2009 at 11:22 AM #

    Thanks.
    Be sure you take time to understand.

  29. LL 11/22/2009 at 11:45 AM #

    Mark,
    Just found your blog here, I am looking for a demo trading station in order to exercise your Iron Condors Index Option.
    Can you recommend one?

  30. Mark Wolfinger 11/22/2009 at 3:25 PM #

    I don’t know what you are looking for.
    Can you elaborate?

  31. Andy W 12/01/2009 at 10:37 PM #

    Dear Mark,
    Since completing The Rookie’s Guide To Options, I’ve moved on and have been furiously trying to absorb the information provided in your blogs. I wanted to give a big thanks for keeping all this information available (and organized into sections).
    I wanted to tell you about a ‘webinar’ on iron condors that I listened to over the weekend, offered by an online broker. The 30 minute presentation was ultimately more of an advertisement for the guy’s brokerage firm than educational, but I did pick up a couple of points, mostly pertinent to his own views on condors but enlightening nonetheless.
    1) He strives for his condors to expire rather than to close them and has even opened them on the morning of expiration day
    2) He closes a condor if the delta reaches .45
    It seemed obvious his techniques were riskier than what you suggest in your book, but I was a little surprised at how different your approaches really are.
    First, though I’m not sure if you’ve ever explicitly said so, I’ve presumed you choose to open condors at least 2 months in advance and typically close them when you’ve made a satisfactory gain from theta decay, preferably far from expiration to avoid high gamma and the rapid swings that stocks go through as expiration day nears.
    His view on delta came after I asked him how delta and theta affected his condor decisions… I was hoping to get some tips on where to open condor positions based on those values; his .45 delta seemed like a sensible guideline but with regard to theta he laughed,
    “We don’t pay attention to theta, we just want to burn through it as quickly as possible!”
    I rolled my eyes after that. Admittedly, my knowledge is just about nil when it comes to using greeks for my positions, but it seemed clear to me that one’s acceptable value of delta would change with the amount of theta left on the option. His next non sequitur statement sort of confirmed that:
    “If we can make even just a 17% gain on a condor in its first week, we’ll take that and close the position”
    So, my conclusion after the event is that there’s a lot of different methods out there, and those supporting the riskier moves seem to be the more outspoken ones. I think I’ll hang out here and gather more information a while longer before I open any index spreads. By the way, if you have any readers who are getting frustrated at not getting the options approval level they want with their online brokers, I figured something out. In addition to having the prerequisite liquid assets and net worth, you need to check off ‘aggressive growth’ and ‘speculation’ as your investing style, instead of simply ‘growth’ which is what I had been choosing. It’s hard not arguing with the people at the other end of the line that spreads are supposed to be protective, not speculative.

  32. Mark Wolfinger 12/02/2009 at 9:15 AM #

    Andy,
    Thanks for sharing.
    Bottom line, some of his comments are unbelievable (17%) and others are ok, but risky.
    More details tomorrow, in a separate blog post.

  33. jonesirene@sbcglobal.net 12/11/2009 at 9:54 AM #

    Hi Mark: I have a question about the break even point in a vertical spreads. Example When I place a Jan 2010 Bull Call spread on a stock that is trading at $227.69: The long cost strike is $230 ask or cost $2.7, short call strike $240 bid or credit $.20 the difference is a debit $2.50 x100 shares per contract ($250 cost for the trade)
    My understanding is that: I am not making any money until the price of the underlying stock gets past $232.50 (my break even),which is the $2.50 I paid plus the $230 long call strike price. At $232.51 I am making money, but until then l then I am only recouping cost.
    Is there another method of calculating the break even, to show when my trade is profitable? excluding the commission.

  34. Mark Wolfinger 12/11/2009 at 10:22 AM #

    Hi Irene,
    Good to hear from you again.
    This requires a lengthy reply.
    It will be published Monday.

  35. Edgardo 12/14/2009 at 2:56 PM #

    Hi Mark:
    With 32 days left on a RUT IC JAN 490/500 660/670 with the RUT at 610, is it wise to roll up the 490/500 to 530/540 getting a credit of .55 being that the 540 delta is .11 or just let it stand there as the original trade, not trying to squeeze any extra?
    Thanks for the very educational Blog and Best Regards
    Edgardo

  36. Mark Wolfinger 12/14/2009 at 3:16 PM #

    Hello Edgardo,
    Thank you.
    There is truthfully no perfect reply to this question.
    If you are willing to take that extra downside risk for an extra $55 per spread (less commissions), then it’s a good trade. If you have only two contracts, that may be $110 in premium, less $40 in commissions. If that’s the situation, don’t do it. It’s too much money for the broker and too little for you.
    I prefer to sacrifice that potential profit – but only because it’s too little extra cash for my comfort zone to take the risk.
    The real problem for you is what to do with the call spread. Many would leave it alone for now. Others might look to make a small adjustment.
    Edgardo: One method for adjusting risky positions is to sell more spreads and collect more cash. That does a decent job of balancing up and down risk.
    But, for me, that’s just too risky. Too little to gain for the cash collected. there is now a much higher probability that one side or the other will run into the money I’d rather deal with the risky side of the trade – either now or later – than sell new, closer-to-the-money options.
    It’s a decision you must make for yourself. I wish I could tell you what to do here.

  37. Doctor Stock 12/14/2009 at 7:53 PM #

    Thanks… I’m interested in the 101 version of Options trading… I only trade straight right now, but based on my successes, I suspect I could do very well if I learned options too.
    What book would you recommend as a great hands-on starting guide?

  38. Mark Wolfinger 12/14/2009 at 8:05 PM #

    You trade straight? Does that mean stocks only?
    101 options trading? That would be The Rookies Guide to Options.
    It’s a comprehensive book that helps you understand how options work and how to trade them. It provides detailed background on the basic concepts on options with examples that teach you to think for yourself.
    The reviews have been excellent.

  39. Doctor Stock 12/14/2009 at 10:50 PM #

    Thanks… any online resources?
    I trade stocks, bonds, short selling, etc., just not options (yet). I hope to make options my goal of 2010 – to learn and test my theories.
    Any online fantasy portfolio resources you’re aware of or free software to track my progress?

  40. Mark Wolfinger 12/15/2009 at 7:58 AM #

    I know covestor.com allows traders to post real time portfolios.
    I don’t know if they include option trades.
    But any broker should allow you to open a paper-trading account where you can make pretend trades and develop theories and test strategies. Do not allow the broker to charge you anything for that account.
    You can get basic introduction to options at optionseducation.org and cboe.com

  41. Edgardo 12/15/2009 at 8:58 AM #

    Thank you very much Mark
    The calls are well in my comfort zone, with the short one having a delta of just .09
    You hit in the nail in being 2 contracts!!!!
    But the commisions are just 26 (ameritrade, 10 per spread plus .75 ea contract)
    Thanks again

  42. Mark Wolfinger 12/15/2009 at 9:17 AM #

    You are welcome.
    You are spending $26 per trade
    That’s a high percentage of that $110 you would collect for making the suggested trade.
    I never let commissions get in the way of a trade – but when you consider the possibility of the trade running into trouble, is it worth it for cash available to you? Only you can make that decision.
    The markets will not remain this calm forever – but when will it change?

  43. Edgardo 12/15/2009 at 9:27 AM #

    Wow! You really fast to answer!
    Yes, .55 is not a lot, and then you have to consider .15 or so to exit the trade, so better let this IC stay where it is.
    Have a wonderful day!

  44. Andy W 12/16/2009 at 5:03 PM #

    Dear Mark,
    I’ve recently been looking to sell ~2 month credit spreads based solely on a favorable premium to delta ratio. ie- if delta is 25 for a 10 point spread I will sell the spread if the premium collected is more than 10 x .25 = 2.5 per lot.
    This got me thinking whether my blind faith in delta is justified. I believe most traders calculate delta on the black scholes model, which relies on historical volatility, or the standard deviation of a stock/index over 3-4 weeks. Obviously, though, previous volatility is only a part of what factors into an option’s value. I’ve noticed some stocks, such as utilities, when compared to other stocks or ETFs at the same price have wildly different premiums for calls that have the same values of delta.
    Is there a consensus on the accuracy of delta in predicting how an option’s price will change? Does anyone use a different volatility formula that takes into account other X factors such as quarterly earnings, time of the year (santa clause effect, summer months when the fed supposedly is less active), or the direction of the market as a whole? Do people frequently claim they’ve devised options calculators that are more accurate than the black scholes model? Conversely, are there certain times when you feel delta is a more accurate predictor of option volatility? Are some indices or stocks more apt to behaving like their deltas predict?
    So, getting back to my original story, I decided to sell january, 10 point spreads (delta of 15) in the Russell 2000 index for 1 buck. If my blind faith in delta is correct, I should net $500 per spread over 15 cycles.
    Happy Holidays!
    Andy

  45. Andy W 12/16/2009 at 5:13 PM #

    Oops. Double checked my math and I needed to net more than $1.5 to make the 10 point spread profitable according to delta. Rookie mistake.

  46. Mark Wolfinger 12/16/2009 at 8:02 PM #

    Happy Holidays to you Andy,
    1) The mistake below is insignificant. We know you can multiply 10 * .15
    2) Obviously this premium to delta ratio must have a standardized time frame. You seems to have overcome that problem by choosing 2-month options.
    3) Yes, delta is determined by the model used to calculate the option’s fair value. But, market makers use implied volatility (as the best volatility estimate right now). Thus, the delta is not based on HV.
    4) The reason all these options have ‘wildly’ different prices is that the implied volatility is very different for each of the groups mentioned. High volatility stocks have an increased probability of making a significant move.
    That’s why delta of OTM options are very different. When IV is 10, there is not much chance the stock is moving anywhere, and OTM options have a low delta. When IV is 90, no options is safely OTM, and delta is higher.
    Thus, if you are using delta to make your decision, you are assuming that current IV is reasonable and that you are willing to sell spreads at your pre-determined price level.
    That means if want to sell OTM option spreads, you are limited in your choice of underlying assets. Very non-volatile stocks/ETFs are not going to give you the premium you demand. Higher IV underlyings will.
    5) As to your ‘consensus’ question: Delta is one of the factors that determines how much the option price changes when the stock moves. Yes, there is a ‘consensus’ that delta is fairly accurate. But, gamma, IV, theta also come into play – and changes in these Greeks can overwhelm the effects of delta. You have seen that any time that IV explodes. Think of option prices one year ago. IV was the primary factor in determining the price of an opion, and delta mattered less.
    6) I know of no volatility formula that takes into consideration the factors you mention. But, many ingenious traders use proprietary software, and it’s certainly a possibility.
    7) The Black-Scholes model is not the primary model. There are others that are more accurate and which have been in use for a long time. But that’s not your issue. These improvements are more subtle than your idea needs. A minor change in delta is not that significant, is it?
    8)I never think of delta as a predictor of volatility.
    You use the term ‘option volatility.’ Volatility is a property of the underlying, not of the option. Unless you are referring to the implied volatility and the volatility of that IV. Delta has no predictive value in that area.
    9) There is something here that does not make sense to me. Stocks ‘behave as their deltas predict’ whenever implied volatility is unchanged. Under those conditions, gamma and IV are constant. The only thing that detracts from delta’s predictive power is theta. Thus, delta is the bog boy in town and it’s predictive value is very high – when IV is constant.
    Your misconception (as I see it) is that you think ‘delta’ fails to predict accurately, when in fact, it’s a change in IV that overwhelms the predictive power of delta.

  47. ivan roth 12/30/2009 at 7:26 PM #

    hi Mark can you tell me how to arrive at a fair value for an Iron Condor

  48. Mark Wolfinger 12/30/2009 at 8:02 PM #

    Good question.
    Full reply tomorrow morning 12/31/2009

  49. conprovataris@optusnet.com.au 01/07/2010 at 10:53 PM #

    Hi Mark
    I typically trade the Australian Market and take the folloiwng trade:
    S 20 x ITM
    B 25 x ATM
    S x 5 OTM
    This typically gives me around 40/45% of the total loss on this credit spread it it goes aginst me (i.e. $4.0/$4.5k credit and max $10k loss)…If my strikes are threatened down the track I typically do the folloiwng as an adjustment:
    B 20 x ITM
    S 45 x ATM
    B 25 x OTM
    This leaves me with:
    S x 20
    B x 20
    Still max loss of $10k…
    Then to get more credit in I will look at the other side calls if original credit spreads was puts and simply
    S x 20 ATM
    B x 20 OTM
    So I am left with:
    B x 20 OTM Calls
    S x 20 ATM Calls
    S x 20 ATM Puts
    B x 20 OTM Puts
    Maximum loss is still $10k, so risk profile has not increased any however now with the extra credit received I have banked approx 75-80% of total loss or $7.5/$8k of max $10k loss…
    Do you have comments or suggestions and if so could you suggest a better defensive measure? Thanks in advance

  50. Mark Wolfinger 01/08/2010 at 8:08 AM #

    Give me more time to look at this. Too complicated for a quick reply.
    But, if you bank almost 80% of max loss, it sounds quite good. Of course it seems to have a high probability of losing. I’ll be back later, erase this comment, and give you a better opinion.
    Good trading.

  51. Mark Wolfinger 01/08/2010 at 5:23 PM #

    1) This position is not quite as good as I thought earlier.
    You own the iron butterfly. This is the same as an iron condor – except there is no space between the strike prices of your short options.
    If you collected 8 for the combined trades, then that is exactly the same as owning the butterfly spread at a $2 debit. Two bucks is a lot to pay for a butterfly, so the chances are high that you will lose money.
    But there is always the small chance that expiration will find your ‘ATM’ options to truly be ATM. If that occurs, the butterfly is worth more than $2 and you can will earn a profit.
    2) “better defensive measure” Difficult question.
    a) At the time you make that final adjustment to own the iron butterfly – if losing no more than $2 on the trade seems to be a good result – then this is a very good method for limiting losses – with a chance to come out with a profit in the end.
    b) There is a trade off. How much would you lose if you simply exit the entire trade and make no attempt to repair it? If that cost is significantly less than $2 per spread (and don’t neglect commissions – you are trading a bunch of contracts) then you must choose between taking that smaller loss – with zero chance to recover vs. the play you described above.
    For example, if you can exit with a loss of $1.20 per spread, making your play is equivalent to making two other trades:
    1) pay $1.20 to exit
    2) pay $0.80 ($2 minus $1.20) to own the butterfly.
    Thus, do you want to own the butterfly at that price? That should not be a difficult decision to make.
    3) The reason this is difficult – is that when it’s time to adjust a losing credit spread of any type, there are many choices. I cannot evaluate all of them, nor do I know what type of risk allows you to remain comfortable with the trade. You appear to be risk averse, and I like that. Your approach is very reasonable.
    If you look at it from the perspective of: do I want to pay for this butterfly and have a chance to win later, or do I want the smaller loss now, then the decision may be easier to make.
    I hope this helps.

  52. Con Provataris 01/08/2010 at 8:57 PM #

    Thanks Mark
    Your insights are very valuable and much appreciated…I hear you in terms of closing it down initailly if it goes against me, that is always my first option, if I am comfortable owing the iron butterly or in fact if I can turn it into an iron condor I would, problem with trying that on the Australian market at the moment is the lack of volatility and hence premium…What are your thoughts on the folloiwng?
    Initial Position:
    S 20 x $23.50 ANZ Calls
    B 25 x $24.00 ANZ Calls
    S 5 x $24.50 ANZ Calls
    Now lets say that ANZ continues to head up I can always undo legs 1 and 2 (i.e. Buy Back 20 x $23.50 and sell 25 x $24.00 as this is a quasi ratio back spread, I have done this in the past at breakeven or even a small credit) and simultaneously sell another 5 x $24.50 and buy 10 x $25.50…This would leave me with:
    S 10 x $24.50
    B 10 x $25.50
    Risk is still $10,000 however now I have rolled this up by $1 instead of the $0.50 as in the previous example, I can do this most times for around breakeven or a small credit and then I can decide if I want to add a wing on the put side…
    Your thoughts are much appreciated….

  53. Mark Wolfinger 01/08/2010 at 9:46 PM #

    Thank you.
    1) If premium is low (and I know commissions are high in OZ), does it pay to trade commission intensive positions? I’m merely asking. Only you know the answer.
    I keep forgetting that options represent 1,000 shares each – so that may make commissions reasonable.
    2) If the upside is causing a problem, have you considered either:
    a) using higher strike prices (see #5) or
    b) not selling the 5 lot, and having a real back spread (I don’t like 5 x 4 back spreads)
    3) Adding a wing on the put side (obviously) generates cash.
    The big question I ask is: Do you do that trade just to generate cash, or is there some market bias in your making that trade?
    4) If you are willing to open the put side when the call side gets into trouble, is there a reason you do not open the put side at the same time you initiate the call position?
    If it’s fear of a market crash – that is something I can understand. But you do sell puts later. That makes me ask: why not earlier?
    5) I like what you have described. Rolling into 10-lots of the higher, but wider, credit spread.
    I’m wondering if you considered making that your original trade. Profit potential is less, but so is risk (not in dollars but in probability of losing).
    Bottom line, I’m sharing some thoughts, but you have things under control.
    Trading strikes one half dollar apart feels strange to me.
    Regards
    Do me a favor. If you continue this thread, please comment on a fresh post. Your comments and my replies are very far down the page and few (if any) people see them.

  54. con provataris 01/09/2010 at 12:53 AM #

    Hi Mark
    Thanks for your quick replies, I hope I am not keeping you from getting some much needed sleep…Comms are high here that is why when I take a trade such as:
    S 5 x $24.00 Calls (OTM)
    B 25 x $23.50 Calls (ATM)
    S 20 x $23.00 Calls (ITM)
    The fact that I am in and very close the the money means I receive approx 40-50% of maximum loss in the credit (i.e. $4-$5k in credit)…Also each contract represents 1000 underlying here which makes it worthwile close or in the money…
    The upside/downside depending which side (calls or Puts) your on is always a problem when so close or in the money that is why I like having that quasi back spread, I have looked at writing further away from the money problem with that is even if you move up one strike (i.e. $0.50) your credit reduces from approx 45-50% of maximum loss to as low as 15-20% of maximum loss and still you have opened a positon only 50 cents or so from the current market…vol has really left our market the last 9 months or so…
    I have thought of writing just pure back spreads and in fact have done so in the past with good success, to do so in this market however with no Vol means I have to open up positions of 50 or 75 or 100 contracts and given I am writing 6-8 weeks out the credit on one of these pure back spreads is still only approx $4,000 – $5,500 and yet the loss is now $50 or $75 or $100k so the risk/reward is dreadful…
    I add the wing of 5 as the third leg to generate credit (cash) otherwise the pure back spread gives me very little cash…
    I dont open the put side unless I get into trouble because doing so on day 1 and trying to open an iron butterfly or iron condor gets me very little credit again and the two sold strikes will only be at most $0.50 or $1 away with 6-8 weeks to run…
    I also like the idea of rolling to the 10/10 spread with $1 between strikes because I do not increase maximum loss and the probabalilty of a credit or even breakeven trade increases…The reason I dont do this from day 1 (i.e. day I take the trade) is so I can have that 20/25/5 quasi back spread ratio or more importantly the extra 5 at leg 2 as that allows me to unfold legs 1 and 2 very cheaply, especially if the market goes against me early on in the trade, and then $1 lower have a 10/10 spread with a $1 difference in strikes…
    On Friday I looked at doing a butterfly on one of our most volatile stocks (NAB) and even taking the following trade was only going to give me approx $1,000 credit with potential maximum loss still $10k 10% Risk/Reward…
    S 10 x $28.00 (ITM)
    B 20 x $27.00 (ATM)
    S 10 x $26.00 (OTM)
    Again thanks for all your ideas and i really appreciate your quick replies they are much appreciated and as professional oppie traders we need to bouce ideas off each other because if we can improve a few % each and every year then that benefits our bank accounts over the longer term….

  55. Mark Wolfinger 01/09/2010 at 1:11 PM #

    I lose no sleep, but It does take a long time to reply.
    Rolling to that 1 point wide spread at a favorable price does seem to be the best solution – if and when trouble arises.
    I’m considering trading less.
    Far too busy with writing to pay full attention to the market – and we all know that’s not a good situation.
    You are welcome.
    Good trading.

  56. conprovataris@optusnet.com.au 01/09/2010 at 9:56 PM #

    Thanks Again Mark and yes I can imagine how busy replying to psots can be and yes I have also been on the end of some bad trades when not really paying enough attention to the market, I call it not giving the market the respect it deserves…
    Can I be so bold as to ask your opinion on this last trade suggestion:
    Initial Trade;
    B x 10 $28.00 Puts (ITM)
    S x 25 $27.50 Puts (ITM)
    B x 15 $26.50 Puts (OTM)
    Maximum loss here is still $10,000 and initial credit around $4-$4.3k so 40-43% of maximum loss…if trades gets into trouble as time passes I can do the folloiwng quite cheaply or a small debit;
    Sell 10 x $28.00 Puts
    Buy 25 x $27.50 Puts
    Sell 15 x $27.00 Puts
    That would leave me with:
    S x $27.00 Puts
    B x $26.50 Puts
    Maximum loss on this spread is $7.5k, so mamimum loss scenario has decreased…
    Your thoughts are agin much appreciated….

  57. Mark Wolfinger 01/10/2010 at 9:57 AM #

    To my bold Oz friend,
    Beginning with the broken wing butterfly is another variable that allows you to morph your position into something reasonable.
    This specific choice looks good to me. I don’t know at what stock price you make your adjustment, but to be short the 26.5/27 spread for half the maximum loss looks like a good trade to me. Unless the 26.5 is almost ITM.
    Your methodology for dealing with troubled credit spreads is intelligent. But that’s not the issue. It comes down to a simple choice: Would you prefer to take the loss or own the new position?
    I agree that the price at which you own the new position is very attractive. But if the chances are too high that this spread is going to give you the maximum loss, then it clearly is not quite as attractive as it appears to be.
    Today’s trade. You are short 15-lots with a $7,500 credit. That’s excellent. But, I’d like to know where the stock is trading before I would make a final decision as to whether I’d want to own this spread. I’d also want to know my alternative. That is: how much would it cost to exit the first trade instead of adjusting.
    These numbers play a role in the decision. [I am not asking you to send those numbers. I am saying those numbers play an important role in making the decision] After all, trading is all about the money and not in building great positions that are likely to lose more money

  58. Himu 01/15/2010 at 1:22 AM #

    Hello,
    I have a question. Let us hypothetically imagine buying a stock XYZ at $5 . Then write covered call of $1 strike price Deep In the Money , let’s say at $4 premium. In that case, delta is possibly at 1.
    Now at close to expiration, what is the chances of getting assigned if …
    * The stock is trading at $4.50 (hypothetically speaking)
    * And the cost of the premium has definitely gone down to lets say $3.50.
    I am curious!

  59. Mark Wolfinger 01/15/2010 at 7:55 AM #

    Welcome Himu,
    The chances of being assigned are 100.0000000000000000%
    The only time an in-the-money option is NOT assigned occurs when it’s ITM by only a penny or two. And even that happens very seldom. It’s so uncommon that you may trade your entire lifetime and never have it happen to you.
    Many rookies believe that if the owner of a call option has a loss, he/she will not exercise it. That is wrong.
    In your example,if the option owner exercises, he/she collects $350. It does not matter whether it’s a profit or loss. If that person does not exercise (by calling the broker and issuing instructions: ‘do not exercise’), then he/she gets zero.
    Would any rational person choose to collect zero and toss $350 into the trash?
    It’s good to be curious.

  60. alok 01/23/2010 at 1:58 AM #

    Dear Mark,
    In your experience in trading iron condors, is there a simple and “safe strategy” for steady income out there which if used over and over will result in a outperformace on the index ? Just curious as getting into this world now ( have been in stocks and fut for 15 yrs)

  61. Mark Wolfinger 01/23/2010 at 8:29 AM #

    No.
    Better, more detailed reply available as a blog post.

  62. Leo 01/25/2010 at 10:42 PM #

    Mark: I came across your blogs as I was looking for ideas about hedging ICs. I have to admit, you have a lot of great info, but I do have a few questions:
    1. Obviously, maintaining a delta neutral portfolio is a challenge since the delta changes as the underlying changes,and maintaining a delta neutral profile can result in a lot of trades. Is there any sort of guideline about what is an acceptable delta or what may be considered excessive delta? I realize that if you have many IC positions, you can’t view the delta on a per position basis, but rather the portfolio as a whole. ThinkorSwim provides a convenient summary, taking into account the types of share (call/put and long/short), delta of the individual position(s) and the number of contracts, or effectively the number of shares. Could you use or is there some sort of guidelines taking into account the total delta value as a function of the total portfolio value?
    2. Can you provide some ‘layman’ examples of how negative gamma can impact a position(s)? Is it possible for negative gamma to impact a portfolio of ICs in both a postive and negative trending market?
    3. In your posting called “Iron condors: Diversification and VIX optons as hedges”, I understand why VIX options should not be used since there may not be any correlation of the VIX optiosn to the underlying ICs, and more importantly, VIX option pricing is based on VIX futures and not the actual VIX index. However, you ever considered or ever heard of someone using something like the Proshares Index ETFs options as a hedge? Specifically, since I almost exclusively trade SPX, I was looking at buying options or debit spreads on UPRO and/or SPXU – which are directly correlated (in theory, at least) to SPX.
    Thanks again.
    Leo

  63. Mark Wolfinger 01/25/2010 at 11:44 PM #

    Reply to be published Thursday, Jan 28, 2010.
    Good questions.
    Thanks Leo

  64. dmansigian@yahoo.com 01/28/2010 at 9:19 AM #

    Mark, I’ve just recently begun learning about options and would like to know what you think about buying shares, buying an at the money LEAPS put and then selling front month at the money calls against the stock. I’ve had no luck searching the web regarding this strategy. Once again, I’m at the point where I don’t even know what I don’t know and would appreciate your feedback.
    Thanks,
    Dave

  65. Mark Wolfinger 01/28/2010 at 9:47 AM #

    Dave,
    This is an important question.
    I’ll give you my thoughts on this. It may take a couple of days, but I will respond asap.
    Thanks for posting.

  66. Dave 01/28/2010 at 11:15 AM #

    Hi Mark,
    I’ve recently started trading iron condors and following you. Thanks for your blog.
    I’ve read in times of increasing volatility that trading double diagonals is more prudent than trading iron condors. It seems to me the market is currently in such a condition, albeit this may be short term. The VIX is up 47% the past two weeks. But, I’ve noticed your recent published trades continue to be iron condors. Why? Do you think now is a good time to transition or at least incorporate double diagonals into the mix?
    Very much appreciate your work.
    Thanks,
    Dave

  67. Mark Wolfinger 01/28/2010 at 11:51 AM #

    Dave,
    Prudent? That’s not a word I would use. Double diagonals have risks that are missing when trading iron condors.
    Yes, DD is a very appropriate strategy. The way I teach the lesson is:
    When deciding between IC and DD, if you anticipate (or want to bet on) an increase in implied volatility (and VIX is a great measure of that) then opening DD is a very good idea.
    The crucial word is ‘anticipate.’ Once the IV has expanded, it’s too late. It’s not only too late, but if you anticipate that IV is going to fall, you should prefer to trade the IC.
    When I do not want to be short vega, that’s when I own a mix. I want to be short vega today.
    Today, I opened IC trades. I definitely do NOT want to open positions that are long vega when IV has already jumped. If you believe IV will move higher, then by all means, go for those DDs.
    The main advantage of the DD is owning vega into an IV increase; not owning it after the increase.
    One problem with the DD is that it’s usually necessary to own a position in which the strike prices are farther apart than they are in the IC. That leads to additional risk. You have the potential gain from a higher IV in the future, but you have the risk of an IV decline plus those wider call and put spreads are dangerous.