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Applying options strategy 'the wheel' to TSLA

Discussion in 'TSLA Investor Discussions' started by adiggs, Apr 16, 2020.

  1. adiggs

    adiggs Active Member

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    I decided to create this thread as a more focused variation of the Option Trading and Advice thread, with that focus on the option strategy known as The Wheel.

    The thing to understand up front - I'm not a financial advisor, nor am I particularly expert in options trading. So far my experience is almost completely in the options selling side. My forays into option buying either ended in large losses, or are currently losing (index puts). But the option selling has worked great for me!

    My first and strongest recommendation - if you're new to options trading, or haven't studied it systematically, then I commend the training here:
    Free Options Trading Course from Option Alpha | Option Alpha

    This took me about 30 hours to go through all of it (1.25x speed worked great for me). And I urge you not to skimp.

    This is both general option trading education, along with education about a particular option trading strategy (selling volatility). You're going through that material for the general education, and you'll pick up information about that particular strategy at the same time (it happens to make use of the same edge in the market as The Wheel).

    From here on, I'm assuming the level of knowledge conveyed in that linked education.
     
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  2. adiggs

    adiggs Active Member

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    The Wheel is conceptually easy to understand.
    - Sell Cash Secured Puts, month after month, until assigned (buy shares).
    - Then sell Covered Calls against your shares, month after month, until assigned (sell shares)
    - Repeat.

    The goal, at least for me, is to earn a reasonably stable source of cash month to month. I think that 1% each month is reasonably achievable from what I've seen so far (a whole month! no that's not a big enough sample). Option premiums on TSLA are so high, I think the bias is to the beating 1% / month side (more like 5% for me the first month).

    Oh - and I'd like to keep my effort level to what I'm already doing to follow TSLA, with as little as 5 hours of additional effort per month (in practice, I've got a ways to get it down that low, but it's not hard to imagine getting it down that far). I don't want another job, and I don't want this to consume much time either (which includes watching the market daily - don't wanna do that).
     
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  3. adiggs

    adiggs Active Member

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    #3 adiggs, Apr 16, 2020
    Last edited: Apr 16, 2020
    Risks I can think of (not intended to be exhaustive):

    There are risks with all option strategies. The first and biggest risk is that selling options has effectively unlimited risk. That's mitigated by having the cash already in place to buy the shares when a put is assigned, or the shares on hand to sell when a call is assigned.

    As a bonus, by having the options you sell fully covered / funded, you'll be able to trade these at very low levels of options authorizations. I've done both of these trades in my Roth IRA, so this may be compatible with your retirement accounts.


    That leads to the smaller and still important risks.
    On the call side, you could sell a call and watch the stock rocket past your strike. Example - you sell an 800 strike call and watch the shares rocket up to $1000 (or $2000). You just missed out on all that upside beyond your $800 strike (ouch).

    On the put side, you sell a $500 put, and watch the shares drop to $250. Yeah, you got what you thought was going to be a good deal at $500, but you missed out on buying shares somewhere between $250 and $500.

    For the first of these, I've got that covered by owning as many long term buy and hold shares as I really want. If the shares do take off and go to the moon, then I've got my shares that will take advantage of that. I also only sell calls at strikes I would be genuinely happy to sell at.

    For the second, I only sell puts at strikes that I'd genuinely like to own the stock at. The premium is a distant secondary concern.

    Another important risk in either direction, is that you buy shares (puts are assigned) and then you can't get at least the strike on the Covered Calls you start selling to turn those shares back into cash. That means you'll lose the difference in those strike prices when your Covered Call exercises. And of course, the reverse in the other direction (you sell your shares through the Covered Call, and then you can't buy replacement shares through a Put sale to get back into shares).


    Another pair of risks I can think of - using margin to back your put sales, or margin to own the shares for your call sales. I don't use margin. If you do use margin, good luck, and maybe let us know how you're doing that and the guard rails you're using to protect yourself.
     
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  4. adiggs

    adiggs Active Member

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    So why do this?

    I have some specific circumstances that makes this strategy particularly attractive to me. I'm a long term buy and hold investor in TSLA (since 2012). I've realized over the years that I study TSLA so much, I now believe that I have an information advantage over the market (including financial analysts, and other professionals). Of course, I could be wrong about that. Or I could be right, but still wrong in my investment decisions where I take advantage of that knowledge.

    For me, this is a mechanism to take advantage of that information advantage.


    In that long term buy and hold category, I own 'enough' shares that if this doesn't earn a dime, I still have enough for what I need. Enough that we're not planning to buy more for the long term buy and hold pool.

    I have enough cash to back Cash Secured Puts, and I'd like to have it working better for me than a money market fund. I'd like to retain most of the liquidity / flexibility though of the cash, and selling monthly options means I'm only committed for a month at a time(*).

    So I think of this, in aggregate, like generating a dividend from my TSLA + Cash holdings.

    (*) The asterisk on the commitment side - if I get assigned on puts, then my cash is turned into shares. It might be more than a month before I get that turned back into cash and during that time I don't have the cash. In addition, it might be a month or more before I even get back to the put strike I bought at, so a quick liquidation could bring a significant loss as well.
     
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  5. adiggs

    adiggs Active Member

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    The important market mechanism that makes this work is that option prices decay to their intrinsic value on expiration day. I'm looking for the options I sell to be OTM on expiration day, so I keep all the premium I collected up front. In addition, the time decay accelerates as you get closer to expiration. It seems like most people target the final 30-60 days to expiration for this sort of thing, while also hoping for the opportunity to close the position much faster than 30-60 days.

    In practice, I'll close the position (buy to close) well before expiration day. I think my target will prove to be 75-90% decline in the option price, though that's flexible.

    I've discovered already that if the options price declines enough, soon enough, then I can close that position and sell a new option quickly. That enabled me to sell options for the April expiration 2 times in March / early April.


    My early example - I sold the May 1500 Call on Apr 14 (2 days ago). That's 50% beyond the ATH, and it's got to get to that strike in 30 days for those shares to be called away. It could be famous last words. :). Or it could be about a 1% return on the value of the shares when I sold that call, earned while holding what I want to hold anyway, over about a 1 month timeframe.

    On March 17th, I sold the April 200 strike Put. The next day, with TSLA dropping more, I sold the April 175 strike Put (new money arrived). TSLA was around $450 then if I remember right. And the crazy thing is that the option premiums worked out to about 4% of the cash I needed to back the options. Two weeks later, those options had dropped far enough in value to buy them back and sell the $375 strike.

    And then 2 weeks later, I was able to buy back the $375 strike puts, and sell the April 24th 500 strike - about a 10 day option - as I didn't want to hold over earnings day (I plan to close on the 22nd or earlier - definitely won't hold to the 24th). I don't yet know about option reaction to earnings day, so I want to watch and learn this time around.

    I know that every month won't be like this.
     
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  6. adiggs

    adiggs Active Member

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    So my ask - there are people on the board with a lot more experience buying and selling options. I know I'm new to this - what would you suggest I go learn more about? Any suggestions for how to do this better?

    My plan around this right now is to see how well it goes, with an eye towards making this a routine part of our portfolio. I'm eager to learning anything people have to offer, and happy to share anything I've learned as well.


    I do plan to post trades and rationale over in the trading thread. I'll leave out quantities (number of options / shares) as I think the education and calling-your-shot works regardless of the multiple.
     
  7. ckessel

    ckessel Active Member

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    I certainly don't have more experience than you :), but I've been doing this for about a month so I'll comment. My goal was to get back in after selling at $595. Stock was dropping fast, I had LEAPS and a few core shares. Dumped everything. Around $500 I decided to get back in and read about this wheel thing.

    My wheel hasn't spun much, but I did learn a bit:
    • The sold put risk was fairly easy to accept. I wanted back in, so I sold a put for the price at that moment. If it dropped a lot lower, eh, I it's the price I would have happily bought in anyway so I'm no worse off.
    • A corollary to that, as you noted, is if the stock went up much I could close my previous sold put and resell a new one at the new higher price. In that way, I wasn't missing out on much of the rise as the put premiums were covering much of it.
    • The sold call risk, once assigned, was harder to accept. I could do the reverse on a price drop, keep reselling calls, but I didn't want to miss a big upswing
    • So, adjustment to sold calls, take 50% of the premium and buy 2x those calls at whatever strike that could buy. If the stock is flat, I win. If the stock is up a little, I win or break even. If the stock goes WAY up, that 2x calls I bought more than makes up for it. Just leaving a window where I'd lose if it went up above my strike + 50% premium, but not enough to get offset by the higher strike 2x calls. Given how TSLA moves, that slow rise doesn't happen much now.
    So far, I'm happy with it. There are gaps where it could be worse than buy and hold, but overall the sold call/put premiums seems to trim some of the volatility off my TSLA holdings. It does involve me being more active in trading. My trades this last month:

    03/16/2020 Sold x TSLA Mar 20 2020 475.0 Put @ 30.5
    03/23/2020 Bought x TSLA @ 475 (assigned due to the sold put, stock was ~435, with premium my basis was $445 so not bad)
    03/24/2020 Sold x TSLA Mar 27 2020 535.0 Call @11 (expired worthless, yay!)
    03/30/2020 Sold x TSLA Apr 3 2020 515.0 Call @ 24.92
    04/01/2020 Bought x TSLA Apr 3 2020 515.0 Call @ 7.4 (bought back early due to the mid-week drop)
    04/06/2020 Sold x TSLA Apr 9 2020 515.0 Call @15
    04/13/2020 Sold x TSLA @ 515 (forced sell due to the call being exercised, stock was $575 :( )
    _due to the above, here is where I adjusted by buying calls in addition to selling a put/call_
    04/13/2020 Sold x TSLA Apr 17 2020 590.0 Put @ 22.5
    04/13/2020 Bought 2x TSLA Apr 17 2020 640.0 Call @ 5.95
    04/13/2020 Bought x TSLA Apr 17 2020 590.0 Put @ 11.73 (big stock rise, bought back my sold put on the cheap)
    04/13/2020 Sold x TSLA Apr 17 2020 610.0 Put @ 19.75 (sell a new put closer to at-the-money)
    04/14/2020 Bought x TSLA Apr 17 2020 610.0 Put @ 2.79 (again, big rise, bought back on the cheap)
    04/14/2020 Sold x TSLA Apr 17 2020 710.0 Put @ 29.15
    04/14/2020 Sold x TSLA Apr 17 2020 640.0 Call @ 80.21 (that 2x I bought in case of a big rise while selling puts? It paid off here)
    04/14/2020 Bought x TSLA Apr 17 2020 710.0 Put @ 22.4 (again, buying back my put, probably premature and greedy on this one)
    04/15/2020 Sold x TSLA Apr 17 2020 750.0 Put @ 29 (as of now, likely to expire worthless, yay!)
    04/15/2020 Bought 2x TSLA Apr 17 2020 800.0 Call @ 10.3 (really curious to see what happens with this tomorrow...)

    This last week has, obviously, been very active due to the stock move. Despite not owning any shares this week, I've done pretty well will the combination of sold x ATM puts and bought 2x OTM calls.
     
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  8. adiggs

    adiggs Active Member

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    You got paid to buy stock you wanted anyway!

    My original position was acquired by selling $29 puts for $1.70. They finished in the money (about 27.50). That's working out ok :)
     
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  9. adiggs

    adiggs Active Member

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    This is awesome.

    And your adjustment to handle upside is interesting - I hadn't thought of that. So many paths here :)

    Clearly, you're going about this a lot more actively than I am. Which also illustrates that there's a pretty big range for this to operate in. Looks like you're also using the weeklies frequently, and by selling near / ATM options, you're getting a LOT more premium than my far OTM approach. And with weekly you can turn this over faster.

    Something I've seen, and looks like you have as well, is that the sold options are frequently closable well before expiration. In the optionsalpha strategy, they target 50% of the theoretical return as the time to close. They are also opening and closing multiple positions a day in their larger strategy, and I'm hoping to open and close <10 positions per month. So I'm probably looking for closer to 75% (when I have another position I'd like to get into) to 90% to enable a smaller / weaker position. I had an option in position to expire worthless, when I decided I was better off closing that one and opening a new one for April 24. Only about $2 in premium on those puts, but that was a lot more than the rough $0.10 that was left for the old option to age out :)

    It's a minor deal, but my broker (Fidelity) enables a close order for .65/share or less for free (no commission). It's to enable good option behavior - clean up small positions prior to expiration. That's a savings of 6.5 cents/share, so that's another good threshold to end things (especially at the smaller premium levels I've been using so far).


    Something I learned that I'm still working into my decision making process for which strikes to sell. You can use Delta as a proxy for Probability ITM. So if the delta on an option is 0.30, that's also a way of saying that the market has priced that option as having a 30% chance of finishing ITM.

    There's several other pieces of info around that.

    For short periods, measured over the life of the market, stocks are a random walk (50% up / down). They end up forming a normal distribution for their ending price. Thus you can calculate what the market prices to be 1 standard deviation for the share price, and that represents the range in which the market says there is a 68% chance of the stock finishin in. You can calculate 2 standard deviations, and that's the 95% range that the market expects the stock to finish within. Where "the market" is the weighted average of all the options in the market, and the prices they're trading at.

    As delta is amazingly close to Prob ITM, around a .30 delta is a 30% chance ITM at expiration. I don't know the theory behind this, but there's a second characteristic called Touch. Touch is the probability of an option being ITM at some point during it's life - that's 2x the chance ITM at expiration. So that .30 delta option has a 60% chance of Touching the strike at some point, but 30% of finishing ITM.


    Here's what I've gotten from all that, that helps me select options to sell.

    Somewhere around the .15/.16 delta, that's the one standard deviation level. (When you sell a put for instance, at 1 stddev it's got 34% above and 34% below the mid point. To finish ITM, it's got to get below the .16 that's below the midpoint). And that's an 84% chance of being OTM. 84% OTM suggests you'll be ITM about 1 in 6, so be ready for assignment twice / year (one sale in 6), or at least ready to make changes to that sold put to avoid being assigned.

    The second stddev is around .03 delta (2.5%).

    From what I can tell, that first stddev - delta's above that level generate much higher premiums / option prices. There's another pretty big pricing change around that .03 delta.

    I'm hoping that with repetition, I'll get an idea of the delta I want to target for my strikes
     
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  10. adiggs

    adiggs Active Member

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    One other relevant thought that's occurred to me. For those trading in a brokerage account, all of this trading is going to generate realized gains and losses. That means we'll also be fighting losses due to taxes (given that we're getting ahead), and that's a pretty big headwind.
     
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  11. ckessel

    ckessel Active Member

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    Yes, a disadvantage is that nothing here is going to be long term gains/losses. It's all short term.

    I played online poker at one point for about 3 years. I was successful, though in the end I made about $10/hour, so not exactly lucrative :). However, it taught me a lot about bankroll management and risk/reward calculations (expected value in poker terms). Those same concepts apply very well to trades, volatility, delta, and so forth. At a somewhat abstract level, every poker bet is a trade, you're putting money in with some expected value back out. The outcome of any one bet is very volatile, but consistently making good bets means you'll make money in the long run.
     
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  12. adiggs

    adiggs Active Member

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    I think that's a highly relevant background. And now you know the odds as well, where these odds are made up by the joint actions of everybody in the market (not reasonably fixed odds as in poker).

    I'm very interested in watching your trades now - I get the general idea of expected value (probably better than most), but I don't have the kind of skin in the game experience as you've had playing poker. I can imagine myself getting much more aggressive about the strikes I'm using (the premiums look mighty tasty) as I get a better association between the long and short term info (previously I've only really cared about the strategy and execution stuff - now I also care about earnings report timing and stuff like that).
     
  13. ckessel

    ckessel Active Member

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    Heh, the poker background certainly helps me understand bank roll management with lots of smaller bets. And a high tolerance for volatility.

    It did not help me learn a lot that was stock specific. The nature of IV, how its fluctuations affect option prices, time decay, and so forth. Those don't exist in poker.

    I had 1750 TSLA shares in 2011. I have less than 250 shares worth of value today. My lack of knowledge cost me a tremendous amount. Most of that was lost opportunity cost rather than actual losses, got out too early and diversified into things that didn't really move, but I also lost a lot of it on bad options because of my lack of knowledge on how options worked. I certainly came out ahead given when I bought those original shares, but oh what could have been had I understood what I was doing.

    I'm still learning, still struggling to make good moves, but I think I'm at least not making really bad moves anymore.
     
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  14. adiggs

    adiggs Active Member

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    Seriously - if you haven't studied options in some other way (from my experience with option alpha, say 20-40 hours or more), then go through those videos. Took me about a week, watching a few hours each evening. It wasn't work - it was fascinating.

    Lots of good stuff about implied volatility, definitions for all the greeks, but on the scale we're both trading (weekly to near months), it's delta and maybe theta that will have noticeable impact.
     
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  15. ckessel

    ckessel Active Member

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    Thanks, I started watching the videos yesterday. Since my failures earlier on, I did a lot of reading on options and I'm pretty familiar with how it all works: volatility impacts, time decay, etc. However, the videos are doing a good job of teaching me why it works, which is very useful, going from knowing various recipes to understanding the principles behind them. Thanks for posting about them.
     
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  16. ckessel

    ckessel Active Member

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    I bought back my sold $750 puts. The stock kept flirting with dropping below 760, so I close them out at a 80% of max profit rather than risk a sudden drop this afternoon.

    My $800 calls aren't looking good :(. And I got greedy on those, I didn't just by the 2x calls, I bought 10x because I really felt there was strong chance of a run this week. That was a mistake. The point wasn't to make lots of money on that 2x, it was to avoid missing out on a rise. By buying 10x I lost 250% of what my sold put gained me. Granted, I had a shot at a huge gain, but buying options is always the more risky and expensive side of the transaction, especially with IV at these levels.

    If I'd stuck with my plan I'd have made a profit this week, which was the point of the wheel, steady income. My 10x buy ran counter to that that goal. Even having a plan, even knowing what I should do, it's not easy to stick to it.
     
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  17. adiggs

    adiggs Active Member

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    This is related to one of the pieces in the options alpha education - having a plan and sticking to it. I'm finding that developing my specific plan is difficult. But by staying really conservative, I'm getting paid as I educate myself. Making money while learning is a pretty good deal :)

    I'm finding that I'm doing pretty well with selling options. Seems like they always go against me for the first few days, then recover and drop in value quickly. Apparently, my primary skill is picking stuff that goes down in value. Thus the importance of selling options instead of buying - I make money when the options go down :D


    Something I just started doing a week ago, and that I like the principle of. I'm selling what amounts to a skewed strangle. A strangle is an options trade where you sell both calls and puts, OTM (or of course, you can buy a strangle). What this does for me is it exposes me to both upside and downside in the TSLA share price and in doing so, it neutralizes me to some degree, to the stock movement. If it's going up, then the puts will perform well. If it goes down, then the calls will perform well.

    A well designed strangle would have equal amounts on each side of the share price, and would target an equal delta on each side - I'm not doing that, so it's not really a strangle. And I skew it by having unequal delta.

    Most important for me, whatever the share price is, I'll get relatively good prices on one side, and relatively bad prices on the other side. This enables me to not worry particularly about the share price or try to predict what it will do. I can just pick out the next option to sell when I close a position, and sell that option immediately. I rather like that dynamic as it saves me time, energy, and worry about trying to pick direction.
     
  18. EV forever

    EV forever Supporting Member

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    I am certainly nowhere close to either of you in experience for trading options - but would love to follow along and learn. Taking cue from @adiggs I just started the Free Options Trading Course from Option Alpha | Option Alpha today - It is really good, very informative.

    My ventures in options have mostly being call options - made myself a good amount of money with that. But I will be the first to admit this was more due to plain old luck than any great strategy execution. I have also being reading up to understand more complex strategies - but have not actually tried those. Recently, I have dabbled a little in selling puts, mainly as a way to make some dividends on cash. In each case I sold a put option with expiration 3-4 weeks out and then closed the position after about a week when the price of the put dropped about 60-70%. Each time made about 1-2% return on the cash tied up for the cash covered put. I am trying to learn better strategies on doing this - although my trades are going to be much more limited than @ckessel.

    I have been investing in TSLA since about 2013 - started with 100 shares purchased in my rollover IRA account from a previous employer. I kept adding a little at a time, and then in 2018 doubled my stake thanks to the $420 going private tweet. When the stock crashed after that, just held on to those shares because I did believe in Tesla and had my bright red Model 3 to support my belief. Then last year in September bought a bunch of call options for Dec, Jan, Feb, March, April, July and Sept - with the intent that any profits would simply be used to buy stock. The Dec ones expired worthless, but all others made excellent returns. The result is that I already have a substantial position in actual shares - these will be long term hold and will not be touched till 2030.

    So, my circumstances are similar - I am looking to learn strategies and quite willing to risk the cash remaining in my account for this. In addition, since I am trading in an IRA account, there is no tax liability to be worried about. The only negative about the IRA account is that it is not approved for margin - but maybe that is a good thing. I am now learning to develop strategy for selling cash covered puts and calls as a way of earning some income on the cash without locking it up for too long at a time.

    My current trade is as follows

    04/17/2020 Sold 1 TSLA May 15 2020 500.0 Put @ $11.49
    Immediately placed a GTC order buy to close @ 2.50

    Thanks for starting this thread - looking forward to follow along with you folks and have some fun while learning!
     
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  19. ckessel

    ckessel Active Member

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    After watching all the OptionsAlpha videos, I'm questioning my choice to do the wheel at all. They hammer home doing lots of small trades (relative to portfolio size) by selling options and slowly raking in the time decay and volatility. I can certainly see, just even on TSLA, some of the vertical spreads that would seem pretty profitable given the IV.

    I'm rather torn on where to allocate money now. The wheel on TSLA would tie up most of my portfolio, but then I think TSLA is awfully likely to go up over the next few years. Is that going to be better than the techniques OptionsAlpha shows? I just don't know.
     
  20. ckessel

    ckessel Active Member

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    After watching a lot of OptionsAlpha videos and playing around a bunch in thinkorswim (used it years ago when I, uh, made crappy choices). Interestingly, you've got to read the comments. OptionsAlpha has one video on paying earnings, but if you read the comments they say they no longer recommend that.

    I'm going to keep selling PUTS to get back into TSLA. I'm reconsidering my buying calls (e.g. 800 or 850 calls) on the other side that are intended to avoid missing out on a big run up. It worked last week, but the IV is so high it's really betting against the house. I'd probably be better off selling a call this week. I can sell a 750 put for $36, a a 800 call for $22 and anywhere between $692 and $858 and I make a profit. I'm rooting for it to drop slightly and get assigned the shares. And if it moves strongly one way, I can close that profitable side and reopen it closer to the new stock price to help mitigate damage.

    One thing OptionsAlpha drives home, and I've certainly experienced, is being on the selling side of high IV is the long term money maker. With earnings not too far away, and IV really high, selling puts/calls looks like the better plan. I don't think the stock has reason to move much before earnings...though that was true the last 2 weeks ¯\_(ツ)_/¯

    When IV drops down to lower levels, I might take my wheel sold each week (e.g. the sold 750 put this week) and buy whatever option that would get me that's 90 days out or so. I'll lose out on the slow growth of the wheel, but accumulate longer term options. If I can do that for a few weeks, I might have 4x options that are 60-90 days out paid for by the wheel PUTs. I could potentially get into a position where a giant jump in stock due to something like a good earnings puts me in a winning lottery ticket position. The downside is, of course, spending those wheel PUT premiums.
     

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