Options trading strategy/advice

[bxr140]

So which do you sell off first. The shares or the options?

FWIW, a couple big thoughts here:

1. Time decay is a pretty small thing on long dated options. My rule of thumb is to never own contracts longer than 1/3 their duration (preferably 1/4) and so the total time decay is pretty minimal. It usually ends up as some single digit % on my initial capital over the life of contract ownership and I just equate that to like an interest rate on a loan or whatever. Gotta pay to play with the leverage offered by options, as it were. (Yes, Rho is actually the thing for interest rates, but that's another conversation.

2. Beyond leverage on underlying movement (∆), the other main reason one trades options is because of their fluctuating volatility. Contract values can often grow (or erode) at significant rates and percentages of positions size depending on what IV is doing, sometimes even more [favorably] than the unwanted impact from unfavorable underlying movement.

Zooming into your situation, in a perfectly ideal world with equivalent ∆ shares vs contracts, you'd want to own 100% contracts in a rising IV environment and 100% shares in a falling IV environment; In a more realistic world you'd have both shares and contracts that sum to a portfolio level exposure to fluctuating IV. (In a mid-low IV environment you'd be heavier on contracts, in a mid-high IV environment you'd lean toward shares, etc.). The trick is trying to determine what kind of IV environment we're in. As shown in the screenshot below (a bunch of IV's fanned out over time), we're certainly well below the mad IV from more recent times, but still a bit above the long term historical rails. Given the consolidation of the IV as well over the past few months, my personal read is that we're probably not quite at the bottom but we're close, and we may well see an IV spike in the next few months. Personally, I'm heavy on contracts, light on shares.

Also note that while far dated options definitely have smaller IV fluctuations than closer dated contracts (IV360 is the grey line), their Vega is really high. Since the impact of volatility on the value of a contract is [change in IV% * Vega], you're still looking at big $ movement in the CV.

3. You can also hedge against time decay and, to a degree, volatility by selling shorter dated options against your long calls. Its easy to get too greedy on this one, but a sensible approach (either all very conservative strikes...or maybe maybe don't cover all of the longs with shorts, and then those shorts can be more agressive...etc) can improve your bottom line. IMHO in context sold calls should not be used as a method of generating income but as a method to minimize losses. That mentality can help a trader not be greedy by throwing away the potential for thousands of dollars of upside potential on the longs for hundreds of dollars of return on the shorts...

 

[gabeincal]

FWIW, a couple big thoughts here:

1. Time decay is a pretty small thing on long dated options. My rule of thumb is to never own contracts longer than 1/3 their duration (preferably 1/4) and so the total time decay is pretty minimal. It usually ends up as some single digit % on my initial capital over the life of contract ownership and I just equate that to like an interest rate on a loan or whatever. Gotta pay to play with the leverage offered by options, as it were. (Yes, Rho is actually the thing for interest rates, but that's another conversation.

2. Beyond leverage on underlying movement (∆), the other main reason one trades options is because of their fluctuating volatility. Contract values can often grow (or erode) at significant rates and percentages of positions size depending on what IV is doing, sometimes even more [favorably] than the unwanted impact from unfavorable underlying movement.

Zooming into your situation, in a perfectly ideal world with equivalent ∆ shares vs contracts, you'd want to own 100% contracts in a rising IV environment and 100% shares in a falling IV environment; In a more realistic world you'd have both shares and contracts that sum to a portfolio level exposure to fluctuating IV. (In a mid-low IV environment you'd be heavier on contracts, in a mid-high IV environment you'd lean toward shares, etc.). The trick is trying to determine what kind of IV environment we're in. As shown in the screenshot below (a bunch of IV's fanned out over time), we're certainly well below the mad IV from more recent times, but still a bit above the long term historical rails. Given the consolidation of the IV as well over the past few months, my personal read is that we're probably not quite at the bottom but we're close, and we may well see an IV spike in the next few months. Personally, I'm heavy on contracts, light on shares.

Also note that while far dated options definitely have smaller IV fluctuations than closer dated contracts (IV360 is the grey line), their Vega is really high. Since the impact of volatility on the value of a contract is [change in IV% * Vega], you're still looking at big $ movement in the CV.

3. You can also hedge against time decay and, to a degree, volatility by selling shorter dated options against your long calls. Its easy to get too greedy on this one, but a sensible approach (either all very conservative strikes...or maybe maybe don't cover all of the longs with shorts, and then those shorts can be more agressive...etc) can improve your bottom line. IMHO in context sold calls should not be used as a method of generating income but as a method to minimize losses. That mentality can help a trader not be greedy by throwing away the potential for thousands of dollars of upside potential on the longs for hundreds of dollars of return on the shorts...

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Just wanted to say that your posts are bookworthy! Thank you for sharing your knowledge, experience and (not) advice!

 

[Wicket]

FWIW, a couple big thoughts here:

1. Time decay is a pretty small thing on long dated options. My rule of thumb is to never own contracts longer than 1/3 their duration (preferably 1/4) and so the total time decay is pretty minimal. It usually ends up as some single digit % on my initial capital over the life of contract ownership and I just equate that to like an interest rate on a loan or whatever. Gotta pay to play with the leverage offered by options, as it were. (Yes, Rho is actually the thing for interest rates, but that's another conversation.

2. Beyond leverage on underlying movement (∆), the other main reason one trades options is because of their fluctuating volatility. Contract values can often grow (or erode) at significant rates and percentages of positions size depending on what IV is doing, sometimes even more [favorably] than the unwanted impact from unfavorable underlying movement.

Zooming into your situation, in a perfectly ideal world with equivalent ∆ shares vs contracts, you'd want to own 100% contracts in a rising IV environment and 100% shares in a falling IV environment; In a more realistic world you'd have both shares and contracts that sum to a portfolio level exposure to fluctuating IV. (In a mid-low IV environment you'd be heavier on contracts, in a mid-high IV environment you'd lean toward shares, etc.). The trick is trying to determine what kind of IV environment we're in. As shown in the screenshot below (a bunch of IV's fanned out over time), we're certainly well below the mad IV from more recent times, but still a bit above the long term historical rails. Given the consolidation of the IV as well over the past few months, my personal read is that we're probably not quite at the bottom but we're close, and we may well see an IV spike in the next few months. Personally, I'm heavy on contracts, light on shares.

Also note that while far dated options definitely have smaller IV fluctuations than closer dated contracts (IV360 is the grey line), their Vega is really high. Since the impact of volatility on the value of a contract is [change in IV% * Vega], you're still looking at big $ movement in the CV.

3. You can also hedge against time decay and, to a degree, volatility by selling shorter dated options against your long calls. Its easy to get too greedy on this one, but a sensible approach (either all very conservative strikes...or maybe maybe don't cover all of the longs with shorts, and then those shorts can be more agressive...etc) can improve your bottom line. IMHO in context sold calls should not be used as a method of generating income but as a method to minimize losses. That mentality can help a trader not be greedy by throwing away the potential for thousands of dollars of upside potential on the longs for hundreds of dollars of return on the shorts...

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Very appropriate to discuss IV. I left that out. And yeah as someone that was selling covered calls during that late Fall early Winter peak the IV was consistently up in the mid 70s and even touching 80. You could get incredible premiums for incredibly high strike prices. I couldn't avoid doing it (and offset the bearishness of it with more shares). That was also a prediction at the time that 700+ was likely overstretched whereas now I think 700 is still low.

I generally concur IV is the key thing being predicted here in determining the tradeoff and that IV is probably on the lower end of the range especially if one takes as a premise that there is about a +50% gap in underlying price that needs to get bridged at some point and will plausibly bring higher volatility with that move.

The breakthrough concept with options for me was to stop really thinking about strike prices or contract dates as much as these Greeks that signify how it behaves in relation to the underlying (and IV) since the strike price and contract date is really way off in the future but you can trade essentially every day and your account value is in real time.

I'm still holding those covered calls incidentally but I bought calls underneath them to pseudo-close the position or 'lock in the gains' when you consider them together for really just the purpose of holding for long term gain.

I believe my strategy going forward here will be to translate the calls to 'effective count of shares' by using Delta as the ratio and if the stock continues to climb then I will sell off shares to keep the total relatively constant between shares + calls * delta. One thing to keep in mind, I think, is that there are no other companies this size with an IV 50+% that I can find. a lot of the FANGs are down in the mid 30s. That means to me I could be quite wrong about the direction of IV from here.

 

[Wicket]

Depends on your risk tolerance.

Personally I'm inclined to believe the SP will be at least $800 by EOY. Thus I'd take out the options profit calculator and work out what your specific LEAPS would be worth EOY in different scenarios (800, 900 (possible), 1000 (unlikely but also possible), 700, 600, 500 (lowest possibility IMO)).

Then compare to what shares would do for you and make a choice based on your expectations and risk tolerance.

But don't forget that you're already overleveraged since your margin debt is too high so taking on extra risk might not be too wise. Are you a buy-and-hold-Ron Baron or are you a bet-everything-on-red-TrendTrader?

I intend to have a very large position through 2030. All the trading is intended to be just a gain-booster but is with a smaller proportion of funds really. So I'm splitting the difference between those two but closer to Ron I'm sure. I'm definitely not as erratic as TT my swing trades are usually based on some general sense of low, median, high price ranges and intended to be responsive more to what the price is than what the news flow or catalysts are and generally expected to have a scale of roughly 6-12 months per new position (although radical price moves are more important than time).

 

[BornToFly]

I'm still selling very conservative covered calls with 850 strikes (did Sept 3rd earlier today), because I see the possibility of another stock split announcement as the biggest potential catalyst to a short term 20% gain. Once we get passed the annual share holder meeting, if there is no stock split news, I will become more aggressive until Q3 numbers are released in the beginning of October. I am hopeful to get over 850 going into or after Q3 earnings, so I will sell more aggressive Puts and less aggressive Calls in October, and then adjust my strategy accordingly. (I've now made more than $1.5 Million selling options since January this year).

 

[Flehmenlips]

I'm still selling very conservative covered calls with 850 strikes (did Sept 3rd earlier today), because I see the possibility of another stock split announcement as the biggest potential catalyst to a short term 20% gain. Once we get passed the annual share holder meeting, if there is no stock split news, I will become more aggressive until Q3 numbers are released in the beginning of October. I am hopeful to get over 850 going into or after Q3 earnings, so I will sell more aggressive Puts and less aggressive Calls in October, and then adjust my strategy accordingly. (I've now made more than $1.5 Million selling options since January this year).

Wow. You must hold a lot of shares.

 

[BornToFly]

Wow. You must hold a lot of shares.

I had a well paying job and put my entire life savings into TSLA since 2013.... But, my brother has a lot fewer shares than me, and he has also learned to make more than he does as a surgeon by selling options. (However, do it wrong, and you can lose A LOT).

 

[Flehmenlips]

I had a well paying job and put my entire life savings into TSLA since 2013.... But, my brother has a lot fewer shares than me, and he has also learned to make more than he does as a surgeon by selling options. (However, do it wrong, and you can lose A LOT).

A very bold and clairvoyant move on your part at that time. Nicely done. I'm playing with selling options with just 3 contracts at this point, but I can see the potential if one held several dozen contracts. As long as you are selling only covered calls, I don't see a risk of losing a LOT. What am I missing?

 

[WattsHappening]

A very bold and clairvoyant move on your part at that time. Nicely done. I'm playing with selling options with just 3 contracts at this point, but I can see the potential if one held several dozen contracts. As long as you are selling only covered calls, I don't see a risk of losing a LOT. What am I missing?

There are those who would say you are 'losing' by selling covered calls by limiting your upside and missing out if/when the SP spikes above your strike price. The old 'picking up pennies in front of a steamroller' argument.

I personally think selling covered calls on a small percentage of your holdings is a prudent way of generating income during a time when the MMs are acting in your favor.

 

[StealthP3D]

A very bold and clairvoyant move on your part at that time. Nicely done. I'm playing with selling options with just 3 contracts at this point, but I can see the potential if one held several dozen contracts. As long as you are selling only covered calls, I don't see a risk of losing a LOT. What am I missing?

I would say what you could be missing is that the people buying those calls from you could potentially make a lot of money. If so, that's what you are missing out on. Is that losing money? I would say so if it negatively impacts your net worth in 5 years. Some would say not because it's money you never had in the first place.

It all comes down to risk/reward and your ability to call it correctly often enough for you to come out enough ahead that it was worth it in the end.

 

[Flehmenlips]

There are those who would say you are 'losing' by selling covered calls by limiting your upside and missing out if/when the SP spikes above your strike price. The old 'picking up pennies in front of a steamroller' argument.

I personally think selling covered calls on a small percentage of your holdings is a prudent way of generating income during a time when the MMs are acting in your favor.

I understand this argument, but can't one simply buy the shares back on a dip (assuming there is one, but there inevitably is) if they are called away? If played carefully it seems that the loss could be managed to be rather small. I guess that's the caveat OP was providing by saying "if you do it wrong".

 

[Flehmenlips]

I would say what you could be missing is that the people buying those calls from you could potentially make a lot of money. If so, that's what you are missing out on. Is that losing money? I would say so if it negatively impacts your net worth in 5 years. Some would say not because it's money you never had in the first place.

It all comes down to risk/reward and your ability to call it correctly often enough for you to come out enough ahead that it was worth it in the end.

In my very limited experience, it seems that buying calls is the highest risk/reward play. It seems far too easy to lose money playing that game. I don't understand how it is done successfully.

 

[BornToFly]

A very bold and clairvoyant move on your part at that time. Nicely done. I'm playing with selling options with just 3 contracts at this point, but I can see the potential if one held several dozen contracts. As long as you are selling only covered calls, I don't see a risk of losing a LOT. What am I missing?

Correct. CC could cause you to lose out on future gains, but you won't lose your house. I sell both CC and Margin secured Puts to double my returns. The Puts can get you in big trouble if the SP drops a lot, the Margin requirements go way up on your Put contracts, and the Margin amount of your account drops like a rock because all your shares are in TSLA. That happened to me several years ago....

 

[elasalle]

In my very limited experience, it seems that buying calls is the highest risk/reward play. It seems far too easy to lose money playing that game. I don't understand how it is done successfully.

Timing.
When MM does a fire sale, you add calls, back up the truck, sell stocks to buy leaps - this is what has best return an has worked for a lot of people here.

When buying calls, there is a bit of hope and luck needed as well. Buying calls was tedious past 2 years, but came with great rewards. April 20 to jan 21 , portfolio ~ doubled every quarter

+ IV has disappeared these days, SP range bound - seems Selling Calls/Puts is better these days. Some catalyst like another split, dividend or some major tech break through(4680, AI, FSD) or big jump in prod numbers and we could be back in another super cycle. cheers!!

 

[BornToFly]

Just to follow up on Put selling. After learning the hard way, I now try to avoid being too greedy. I sell fewer contracts and keep a BIG margin safety buffer. I also try to sell for expiration dates 2-4 weeks out, and try to sell them after a dip. When we dropped into the upper 500s recently I was selling them like crazy because I wasn't too worried about going lower. More recently, I sold 30 contract for 8/27 expiration and 620 strike for $72,000. They are now worth just under $10k. I will either let them expire worthless on 8/27, or buy them to close in two weeks when they have little time value and immediately sell another batch. I also have 10 contracts with 700 strike that were under water for 2-3 months, but I just kept rolling them about a week before expiration, and making another $15k in time value each month. I did have enough cash and margin to buy the shares had they been assigned prior to rolling them.

 

[CHGolferJim]

There are those who would say you are 'losing' by selling covered calls by limiting your upside and missing out if/when the SP spikes above your strike price. The old 'picking up pennies in front of a steamroller' argument.

I personally think selling covered calls on a small percentage of your holdings is a prudent way of generating income during a time when the MMs are acting in your favor.

I encourage you to read more of this thread — learn how to write more aggressive covered calls and then roll over as needed (also profitable) to protect your shares ownership in almost all scenarios. This largely eliminates the “limiting the upside” concern.

 

[bxr140]

In my very limited experience, it seems that buying calls is the highest risk/reward play. It seems far too easy to lose money playing that game. I don't understand how it is done successfully.

It is not. Selling puts, for instance, is far more risk with far less reward. Aggressive covered calls are also to be avoided, and certainly on core shares.

Though, to be fair, buying calls the wrong way is also very high risk/reward, and to be fair, its much easier to do it wrong than to do it right. Wrong, for instance, is buying a TON of short expiration calls. Wrong, for instance, is deciding you want to buy $100k worth of options instead of $100k worth of shares.

 

[adiggs]

A very bold and clairvoyant move on your part at that time. Nicely done. I'm playing with selling options with just 3 contracts at this point, but I can see the potential if one held several dozen contracts. As long as you are selling only covered calls, I don't see a risk of losing a LOT. What am I missing?

The first observation is that there is no such thing as free money, or risk free return. If there were free money then you can be certain that there are bigger fish with more funding and better tools in the sea that will have purchased all of the free money. As a result, any time you can't identify the risks and rewards or costs and benefits in something, then you haven't looked hard enough. Keep looking because they are there. Ask questions (as you've done)!


With covered calls, when we simplify it down to only considering the situation at expiration, you are trading potential gains for short term income. WIth shares at $710 right now, if you sell the $800 strike call, then you're trading whatever premium you receive in exchange for losing any share price gains over $800 (before the expiration date).

When it all goes as planned you keep the premium as the shares are under $800 at expiration AND you continue benefiting from the share price as it goes beyond $800. An extremely simplistic description that leaves out plenty of details.

The risk of losing a LOT is opportunity cost, rather than "I have less money today than I had yesterday" kind of loss. E.g. you sell the $800 call and by expiration the shares are at $1200. You got the premium and you get to sell your shares at $800 (which might have looked like a good deal when you sold the call). Except that you COULD have sold the shares for $1200 if you hadn't sold the call, so you've missed out on $400 gain. Thus the opportunity cost.

This might sound like a ridiculous made up example except that last year the shares went up so much this could easily have happened. A couple of times actually - the split announcement and then the S&P inclusion announcement were both sharp moves up; these come to mind immediately.


First suggestion if you haven't already - the first page of "The Wheel" thread (Applying options strategy The Wheel...) has a link to beginning education on options trading. The three chunks, as I think of them, are 1) option basics, 2) getting into a trade, and 3) getting out of a trade (or managing a trade if you prefer). It's maybe 30 hours of videos in total and I would consider that to be the minimum knowledge to be doing very much with options.

 

[Chunky Jr.]

I'm a total options newbie and have a very basic question...

Looking at the options chain for an example, consider a Jan 21, 2022 call @ $850 goes for about $50. If I sold one of those, my proceeds would be about $5000. When 1/21/22 rolls around, if the stock is below $850, then the call expires worthless and I keep the $5000. However, if the stock is above $850, then someone buys 100 shares from me for $850 each, so my proceeds would be $85K. Is this correct?

The downside is if the stock is significantly above $850, say $950, then I'd miss out out on $10K of gains.

Do I understand this correctly? If not, any correction(s) would be welcome.

 

[bxr140]

However, if the stock is above $850, then someone buys 100 shares from me for $850 each, so my proceeds would be $85K. Is this correct?

No.

If you’re selling a naked call, that means you don’t have the shares to sell in the first place... So if the contract expires in the money you will be forced to buy shares at market price and sell them at $850. If shares are $900 at that point, you lose $5k on the share transaction. ($50 loss x100 shares.) Of course, you collected $5k on the front end of the trade so your total is basically net zero.

If market price is $950 at that point you lose a total of $5k, $1000 at that time and you lose $10k, etc.

If you’re selling a covered call—either as a buy write or if you already own the shares now—then your gain/loss on the shares are a function of your share purchase price vs your share sale price (the latter of which is fixed at $850).