Options trading strategy/advice

[adiggs]

I've absorbed pretty much all the OptionsAlpha stuff. The videos available for free are pretty dense in content, well done. Kirk, the owner, calls himself a numbers guy and I can see why. However, as a numbers myself, the trading strategies seem to slim on profit. Maybe someone can explain where I've missed something.

Here's a typical trade they mention, using imaginary stock FOOBAR:
Sell $30 calls for $2.50 each that have a 70% chance of being out of the money at expiration
Buy $35 calls for $1 each
Net credit: $1.50 per share or $150 on 1 option.

Kirk then says that $1.50 is the minimum you're looking for. Why, because:
$500 max loss * 30% chance = $150 -- same as your premium.

So, this is a net zero trade from a math perspective. Now, it's not all that simple, it's really integral calculus to figure out expected losses, not a simple 70%/30%, but it's a reasonable approximation for small gaps in strike prices (which is what they recommend). Still, that net zero is what seems questionable about the strategy. You need to have a positive net on average to make money. And even if you get particularly favorable $1.60 credit, you're only netting $10 on average. And that's not including the commissions, which are going to eat about 20% of that $10 at 65 cents per option on TDAmeritrade. And the smaller the stock price, the more the commission eats at your profit.

Plus, he recommends closing positions at 50% of max profit. If you took in $150, close when it'd only cost you $75 to take it back. Which seems questionable as you're cutting max profit in half, but you're not cutting max losses in half.

Bankroll management, no more than 2-3% of your portfolio on any one trade and no more than 60% actually in trades. Sound advice, use the law of large numbers for safety. But, 60%/3% = 20, so 20 open positions. Each position has a lifespan of about 30 days. 20 positions over 30 days at maybe $10-15 profit per position is a whopping $200-300 a month on profits...

With careful searching and orders, I've played about 6 of these trades to test things out. Small positions, losses are capped, so it can't hurt me too much.

Maybe someone can tell me what I'm missing, because I don't see any way for this to scale to making more than pizza money, even with a bankroll of $100,000 or more.

I've mostly arrived at the same conclusion, but I do see a path to better results (better than pizza money ).

1) have a big enough bankroll, that you're trading 10 contracts at a time (or some other number > 1). You still have the bankroll management, so the number of open trades remains high. But if you have $1M you're doing this with, then your individual positions will be more like $10k - $30k worth of buy power, where each contract is going to be a small amount of buy power. You might be trading more like 100 contracts / position in order to get each position up to the 1-2% target.

Example (totally made up): If a 1 contract credit spread has a $200 buy power / margin requirement, then you'll need to trade 50 of these to get to a $10k position size. 50 contract position sizes at $10 profit / contract gets you to $500 / position, $10-15k / month. This is also a 1% position size, so you can have 50-60 positions on at a time; that might get you to $30-45k / month. (Which is pretty good, but it's also a full-ish job that needs a $1M bankroll).

2) What I took away from the videos in the third track where he gets deep into position management and adjustments. For losing trades, there's a number of things you can do to avoid max loss. If your typical loss is closer to 20% of max loss, then that moves the numbers over large # of trades in your favor pretty significantly.

3) One of the reasons for the 50% profit target is that there's a decently large number of trades that reach that threshold, that if held later will go flat or negative later. This further increases the win rate, as well as turning over buy power into new trades much faster than the 30 day full trade length. What I remember is that their typical trade is turned over in 1/2 the expiration time (so 15 days on 30 day trades).

4) And remember that the IV overstates HV, so the 70/30 that he designs his trading system around is really more like 75/25, or whatever that HV / IV difference / edge would yield.

Also worth noting - he mentions that though they do still use credit spreads such as you describe, they do a lot more open ended trades such as selling strangles now (given that they can find high IV stock / ETF to trade). Presumably the theoretical profit is much better - though likely losses are harder to calculate as max losses are in theory open ended, but in practice not.


The net I took away from it - you design the trades up front to be roughly $0 expected value, with the early closes and adjustments providing the rest of the edge you need to make small steady profits. To make it into an income you live on, you'll need a large bankroll, and to treat it like a job. It might be a part time job, but it's something you're doing 2-4 hours every day. One advantage it has is you can start learning the system with a small bankroll while working; if/when it works for you, you can transition away from work later as your bankroll expands and you gain experience / skill.


All of which sort of sounds like I'm arguing for that trading system. I am definitely not. It's definitely not for me. It's way too close to day trading for my taste, energy, or time availability.

This option trading strategy is called "Selling Volatility". Here's one of the primers that talk further about this:
Option School: What the Heck is “Selling Volatility”?

EDIT: Another article, more detailed.
http://www.riverparkfunds.com/Data/Sites/17/media/docs/news/Structural_Alpha_White_Paper_Final.pdf

 

[ckessel]

FWIW, I agree with the other stuff you mentioned. Though, their concept of adjusting a trade is...just another trade. Trying to adjust a bad trade is just sunk cost fallacy. Either the new trade is good or it isn't. You're closing a bad one and opening a (hopefully) better one. If it happens to be on the same stock, that's just where the math took you.

Their closing at 50% profit is actually a form of that as well. They close so they can reopen another trade closer that magic 30/70 on a new trade, the theory being the new trade is at a better profit margin at that point.

You might be trading more like 100 contracts / position in order to get each position up to the 1-2% target.

Theoretically, yes, in practice it seems impossible. The volume on most stocks just isn't there to support so many contracts. Just trying to fill 10 contracts at a favorable credit on a vertical spread can be difficult.

 

[Robertj]

There is some great option advice in the history of this place , see

Newbie Options Trading

 

[EV forever]

I've mostly arrived at the same conclusion, but I do see a path to better results (better than pizza money ).

1) have a big enough bankroll, that you're trading 10 contracts at a time (or some other number > 1). You still have the bankroll management, so the number of open trades remains high. But if you have $1M you're doing this with, then your individual positions will be more like $10k - $30k worth of buy power, where each contract is going to be a small amount of buy power. You might be trading more like 100 contracts / position in order to get each position up to the 1-2% target.

Example (totally made up): If a 1 contract credit spread has a $200 buy power / margin requirement, then you'll need to trade 50 of these to get to a $10k position size. 50 contract position sizes at $10 profit / contract gets you to $500 / position, $10-15k / month. This is also a 1% position size, so you can have 50-60 positions on at a time; that might get you to $30-45k / month. (Which is pretty good, but it's also a full-ish job that needs a $1M bankroll).

2) What I took away from the videos in the third track where he gets deep into position management and adjustments. For losing trades, there's a number of things you can do to avoid max loss. If your typical loss is closer to 20% of max loss, then that moves the numbers over large # of trades in your favor pretty significantly.

3) One of the reasons for the 50% profit target is that there's a decently large number of trades that reach that threshold, that if held later will go flat or negative later. This further increases the win rate, as well as turning over buy power into new trades much faster than the 30 day full trade length. What I remember is that their typical trade is turned over in 1/2 the expiration time (so 15 days on 30 day trades).

4) And remember that the IV overstates HV, so the 70/30 that he designs his trading system around is really more like 75/25, or whatever that HV / IV difference / edge would yield.

Also worth noting - he mentions that though they do still use credit spreads such as you describe, they do a lot more open ended trades such as selling strangles now (given that they can find high IV stock / ETF to trade). Presumably the theoretical profit is much better - though likely losses are harder to calculate as max losses are in theory open ended, but in practice not.


The net I took away from it - you design the trades up front to be roughly $0 expected value, with the early closes and adjustments providing the rest of the edge you need to make small steady profits. To make it into an income you live on, you'll need a large bankroll, and to treat it like a job. It might be a part time job, but it's something you're doing 2-4 hours every day. One advantage it has is you can start learning the system with a small bankroll while working; if/when it works for you, you can transition away from work later as your bankroll expands and you gain experience / skill.


All of which sort of sounds like I'm arguing for that trading system. I am definitely not. It's definitely not for me. It's way too close to day trading for my taste, energy, or time availability.

This option trading strategy is called "Selling Volatility". Here's one of the primers that talk further about this:
Option School: What the Heck is “Selling Volatility”?

EDIT: Another article, more detailed.
http://www.riverparkfunds.com/Data/Sites/17/media/docs/news/Structural_Alpha_White_Paper_Final.pdf

FWIW, I agree with the other stuff you mentioned. Though, their concept of adjusting a trade is...just another trade. Trying to adjust a bad trade is just sunk cost fallacy. Either the new trade is good or it isn't. You're closing a bad one and opening a (hopefully) better one. If it happens to be on the same stock, that's just where the math took you.

Their closing at 50% profit is actually a form of that as well. They close so they can reopen another trade closer that magic 30/70 on a new trade, the theory being the new trade is at a better profit margin at that point.


Theoretically, yes, in practice it seems impossible. The volume on most stocks just isn't there to support so many contracts. Just trying to fill 10 contracts at a favorable credit on a vertical spread can be difficult.

I have been following this discussion closely, in this thread as well as the 'Wheel' thread and have also gone through most of the Options Alpha videos (I admit I skipped a few, seemed to be too much repeat stuff in some of the later ones),

We all seem to be slowly coming to a similar conclusion - this level of continuous trading is not for me either. Kirk talks about following similar strategy for a bunch of stocks, in fact it is essential to do this to make the kind of profits he talks - not my cup of tea to put money into stocks I don't know or don't care about. However, I did learn a lot about generating some income selling options, which I think is viable.

Tesla is the only company I truly care about, and also a company that I am very familiar with from an investing perspective. As I mentioned before, I currently own more stock that I consider my long term hold. So my strategy will be to generate some dividends while I hold this stock by selling covered calls or cash covered puts. In each case, I plan to only sell calls with low probability of assignment, even if that means low ROI. The way I would look at it, currently holding my stock makes me no money. So even if I can make 5% ROI, it is dividend that I would not be getting otherwise. Similarly, the cash covered puts would get be better returns than the money market account that my broker holds the cash in.

For now, I will be buying/holding calls through the ER. I guess we should be wishing each other good luck for that!

 

[adiggs]

I have been following this discussion closely, in this thread as well as the 'Wheel' thread and have also gone through most of the Options Alpha videos (I admit I skipped a few, seemed to be too much repeat stuff in some of the later ones),

We all seem to be slowly coming to a similar conclusion - this level of continuous trading is not for me either. Kirk talks about following similar strategy for a bunch of stocks, in fact it is essential to do this to make the kind of profits he talks - not my cup of tea to put money into stocks I don't know or don't care about. However, I did learn a lot about generating some income selling options, which I think is viable.

Tesla is the only company I truly care about, and also a company that I am very familiar with from an investing perspective. As I mentioned before, I currently own more stock that I consider my long term hold. So my strategy will be to generate some dividends while I hold this stock by selling covered calls or cash covered puts. In each case, I plan to only sell calls with low probability of assignment, even if that means low ROI. The way I would look at it, currently holding my stock makes me no money. So even if I can make 5% ROI, it is dividend that I would not be getting otherwise. Similarly, the cash covered puts would get be better returns than the money market account that my broker holds the cash in.

For now, I will be buying/holding calls through the ER. I guess we should be wishing each other good luck for that!

This is pretty much exactly my situation. (Minus holding options through ER )

I'm a fan of getting started - maybe after earnings. My first put sales were monthlies at 200 and 175 strikes. Made about 2 or 3% on those trades in 1/2 of the time to expiration, so I got to sell puts again for that same monthly strike.

My first covered call was also a monthly, with a strike of 1500. Just in front of that significant move a few weeks ago - I found myself seriously wondering if the stock would just keep running. Of course it didn't. I learned then that I'm much more worried about risks to the upside.


All of which is to say - I'm a fan of getting started. Having skin in the game, even if it's just 1 contract to start, will get you studying option chains and turning the knowledge from those videos into experience. I find that I'm growing more aggressive in my sales (where aggressive is still a long ways OTM).

I hold onto two ideas constantly - this is intended to be a dividend strategy first and foremost. And I spend time on every trade thinking about tail risks, and whether I can look at myself in the mirror if I get hit with 1 that affects any of my positions.

That being said, I've gone into this thinking that 1% per month would be an outrageously good dividend and that's sort of my mental standard (which further helps me stay FAR OTM). I'm starting to think there's more to be had than that.

 

[ckessel]

As I said before, I'm trying out the strategies. If it makes a few hundred a month or more to keep 10 positions open and it's not causing me any heartache then I'll probably do it. But, it takes probably 30 minutes a day to find a trade to make. Well, try to make, the order on the necessary spread doesn't always fill.

It's sort of clinical though. I believe in TSLA, I don't believe in any of these other stocks or know much about them. I suspect once the academic interest in the trading mechanisms wears thin, I'll stop. Just won't be worth the time and effort for the profit margins I'd be making.

 

[pz1975]

I wanted to share a costly options lesson for me. I have been trading options for 7 years now and feel like I have a good understanding of them.

I sold some $727.50 TSLA calls just before expiration Friday and was happy to pocket the $0.10 per contract once the SP closed below that at $725.10. When I woke up this morning, I noticed that 900 shares of TSLA had been sold in pre-market at $727.50. I called my broker and found out that someone had exercised 9 of those sold contracts just after close Friday even though they were out of the money (I didn't realize that was possible). The problem is that they weren't sold from my account until 8:22 am EST this morning (that's when my brokerage found out about the assignment since they are closed over the weekend) and my brokerage didn't call me to let me know. So I was down 900 shares as the SP rose up over $780.

The broker I spoke to said he has only ever seen that happen 3 times in 4 years and admitted it is extremely rare and said he would try to change the policy at the brokerage to call a client if that happened again since I explained that I would have just immediately bought them back in pre-market if I had known (SP was $735 at the time which would have been a small loss). He admitted that there should be a policy to call someone in that very rare situation but it doesn't exist currently. I bought them back this morning at $781 rather than waiting for a dip (these are my core shares) so I ended up losing $48K from this lesson.

Sucks for me but figured i would share.

 

[adiggs]

Ouch. Thank you for sharing that.

This has me wondering - how long after market close are options exercisable? Do they effectively continue to trade in the after market? Or maybe an exercise decision can be made after market close for some period - in effect gaining the ability to buy or sell during a period that is otherwise unavailable?

 

[ckessel]

Wow, someone _knew_ something. Lesson learned, I'll close my sold calls if they're anywhere remotely near the money before the close on that Friday!

 

[pz1975]

Ouch. Thank you for sharing that.

This has me wondering - how long after market close are options exercisable? Do they effectively continue to trade in the after market? Or maybe an exercise decision can be made after market close for some period - in effect gaining the ability to buy or sell during a period that is otherwise unavailable?

My broker told me they could be exercised up to 30 mins after close, and the main point here is they can even be exercised if out of the money at close. That was the part I didn't know.

 

[adiggs]

I realize there are important limitations on max pain theory. I found this article helpful for understanding the idea, as well as some of the market mechanisms that don't require active share price manipulation by market makers, to account for the dynamic:
https://www.thestreet.com/opinion/k...-when-it-comes-to-options-expiration-12680626

The primary limitation I can identify is to not read too much into it - especially on expiration days for weeklies. Put another way, this market moving force becomes more important with more open options.

According to this site (are there other sites that do these calculations?):
Stock Option Max Pain

Max pain this week is in the 685-715 range, with 700 at the max. That will change over the week. I figure this translates into a pull down from the current levels, while also thinking that as a weekly, max pain is this week is more like the moon's gravitational pull than earth's (or the sun as we might see at the January LEAP expiration).


I've got the second site bookmarked now, so I can easily see how max pain is shaping up for the week. I hope that most of the time I'm far enough OTM that my options don't show up on the chart (as they don't right now).

 

[ggr]

Ouch. Thank you for sharing that.

This has me wondering - how long after market close are options exercisable? Do they effectively continue to trade in the after market? Or maybe an exercise decision can be made after market close for some period - in effect gaining the ability to buy or sell during a period that is otherwise unavailable?

Yes, you can exercise the option any time the brokerage is open. I have done it twice, although I can't remember the specific reason at the moment.

 

[EV forever]

My broker told me they could be exercised up to 30 mins after close, and the main point here is they can even be exercised if out of the money at close. That was the part I didn't know.

That is the really disturbing part! I have always assumed if the calls are OTM even by 0.01 at expiration, then they expire worthless. In your case, the calls were clearly OTM by about $2, so they should have expired worthless. The broker should never have been able to assign them after market close, doesn't matter if the broker was open or not.

Now I am wondering though, can they still be exercised in after hours trading?

Fidelity requires accounts to be approved for after hours trading - my account is not approved since I have never requested it. But if the buyer of the calls can exercise in after-hours, then can they force those to be assigned from my account, even if I am not approved for after hours trading?

 

[pz1975]

That is the really disturbing part! I have always assumed if the calls are OTM even by 0.01 at expiration, then they expire worthless. In your case, the calls were clearly OTM by about $2, so they should have expired worthless. The broker should never have been able to assign them after market close, doesn't matter if the broker was open or not.

Now I am wondering though, can they still be exercised in after hours trading?

Fidelity requires accounts to be approved for after hours trading - my account is not approved since I have never requested it. But if the buyer of the calls can exercise in after-hours, then can they force those to be assigned from my account, even if I am not approved for after hours trading?

I would say yes to your question since it probably only matters what the buyer of those calls does (ie. has 30 mins to exercise after market close). And technically it isn't after-market trading since the option is exercise is based on the closing price from market hours. Note that if TSLA had dropped at open today I would have happy that this happened of course since I could have just bought them back cheaper. Just a very odd thing to happen and as I said, my broker said that he has only ever seen this happen 3 times in 4 years of full-time work as a broker.

 

[ckessel]

We'll see what happens come May 15th when my 10 positions expire, but it looks grim. I think the OptionsAlpha stuff is basically a scam to get you to buy their membership. Maybe scam is too harsh, but the math just doesn't hold up.

The problem is when you lose, you're usually going lose the full amount. You're purposefully picking high volatility stocks, they're not often going to end up between the 2 strikes, so it's either a full win or a full loss. If you've got their magic $1.50 credit on a $5 wide strike price that means a maximum loss of $350 (500 - 150 credit) per option.

They have you sell at 50% profit, or $75 profit on the above example. $350 max loss, $75 max profit. You need to win 79.6% of the time (1 - 75/350) to just break even with that strategy. And that doesn't even include the impact of commissions. Maybe there's some tiny profit you can eek out over the long term, but it's not going to be much.

 

[c041v]

I'm really hemming and hawing over what to do with ER today. I'm considering a straddle, which seems like it would be the most effective way to capture the news that will likely force a 10-20% move in the price (based on other threads where I read that Options pricing this week suggests this)

I have not used a straddle before, and I'm wondering about a few things;

1. Would I be better served by very short term calls to catch the immediate fallout (01-May expiry), or something longer in case it takes a few days for the market to digest?
2. Do ATM strikes make sense, or can I lower my outlay by going OTM on either end, realizing that even $100 OTM would likely be in ITM after the ER?
3. How does the IV crush factor into what the project profits are currently? (I'm using optionsprofitcalculator.com)

I've played Calls in Earnings before, and occaisionally Puts, but trying to wisen up (If I was really smart, I'd avoid Options altogether) by protecting myself somewhat with this strategy.

 

[adiggs]

I'm really hemming and hawing over what to do with ER today. I'm considering a straddle, which seems like it would be the most effective way to capture the news that will likely force a 10-20% move in the price (based on other threads where I read that Options pricing this week suggests this)

I have not used a straddle before, and I'm wondering about a few things;

1. Would I be better served by very short term calls to catch the immediate fallout (01-May expiry), or something longer in case it takes a few days for the market to digest?
2. Do ATM strikes make sense, or can I lower my outlay by going OTM on either end, realizing that even $100 OTM would likely be in ITM after the ER?
3. How does the IV crush factor into what the project profits are currently? (I'm using optionsprofitcalculator.com)

I've played Calls in Earnings before, and occaisionally Puts, but trying to wisen up (If I was really smart, I'd avoid Options altogether) by protecting myself somewhat with this strategy.

My general and first recommendation to anybody and everybody with option questions - check out the free education at www.optionalpha.com. There's about 30 hours over 3 tracks covering the basics of options, getting into a trade, and then getting out of a trade. They've got a particular trading strategy that they are also teaching, but mostly what I learned was basics on how options work.

If you don't already have that minimum level of education on options, then that's my real answer - that's the starting point to answer your questions.

Straddles and strangles are something that OA makes use of (strangles primarily, and they're selling rather than buying), so you'll get lots of insights into profit curves and other stuff germane to your questions (I realize that this won't answer your questions to make a trading decision today or tomorrow).



Straddles and Strangles are the same idea - you buy a call and a put at the same time, looking for a stock price move that is large enough that 1 option will generate a profit over the cost of both options.

A strangle is the same idea - you just move the put and call strike prices out. You can balance them (say both are $100 OTM) or you can skew them (one is $50 OTM, and the other is $100 OTM).


1) With the 5/1 options (this Friday expiration), you will only capture 2 trading days worth of earnings reaction. With the 5/8 options, you get 7 days worth of earnings reaction. And of course, you'll pay extra, though unlikely that you'll pay 3x. Which is better of course is your decision. I know that when buying options, I tend to get something wrong, and there are 3 dimensions you can be wrong in when buying an option (timing, direction, volatility change).

2) Yes! Straddle or strangle make sense depending on what you're trying to accomplish. If you're trading around a $100 move up or down, then you'll need to see if going say $50 each direction yields a better profit and/or similar profit at lower risk. My guess is that the straddle will have the earliest break even and the most money on the table to be lost (share price stays flat), while the strangle will buy you leverage for an outstandingly big move (the leverage comes from the lower price, enabling you to buy more positions or lower your commitment; while increasing your odds of a complete loss if the shares trade between your strikes).

3) When IV goes down, the option price goes down. When IV goes up, option price goes down. As an option buyer, that's one of the dimensions you'll be swimming against - your option value will go down as IV goes down. Assuming that IV crush happens post earnings, then you'll see the options you bought immediately go down in value - your options calculator probably allows you to input your own IV. Try out those options with a 100% IV or 120% (down from 167% IV right now) and see what that does to the price.


I'm not a financial planner etc.. I've really only started trading options a month or 2 ago, and I focus on selling options. I didn't start selling options until I'd finished the OA education I mentioned up top.

Assume that my information is bad and wrong without your own confirmation from other sources

 

[hershey101]

I wanted to share a costly options lesson for me. I have been trading options for 7 years now and feel like I have a good understanding of them.

I sold some $727.50 TSLA calls just before expiration Friday and was happy to pocket the $0.10 per contract once the SP closed below that at $725.10. When I woke up this morning, I noticed that 900 shares of TSLA had been sold in pre-market at $727.50. I called my broker and found out that someone had exercised 9 of those sold contracts just after close Friday even though they were out of the money (I didn't realize that was possible). The problem is that they weren't sold from my account until 8:22 am EST this morning (that's when my brokerage found out about the assignment since they are closed over the weekend) and my brokerage didn't call me to let me know. So I was down 900 shares as the SP rose up over $780.

The broker I spoke to said he has only ever seen that happen 3 times in 4 years and admitted it is extremely rare and said he would try to change the policy at the brokerage to call a client if that happened again since I explained that I would have just immediately bought them back in pre-market if I had known (SP was $735 at the time which would have been a small loss). He admitted that there should be a policy to call someone in that very rare situation but it doesn't exist currently. I bought them back this morning at $781 rather than waiting for a dip (these are my core shares) so I ended up losing $48K from this lesson.

Sucks for me but figured i would share.

This is precisely why I have the habit of closing out any contracts I write (calls or puts) for a few cents. I usually close it out somewhere between $0.1 and $0.25... Sure I lose out on that extra $25 or whatever. But I don't want to mess with the price fluctuations in the last 5-30min before close. Especially in high vol envs, or on high vol. stocks.

Let that be a lesson to others following this thread. Don't try to eak out every penny... Be happy when you get a 80%, 90% or 95% of the total value of that trade, and just get out.

 

[pz1975]

This is precisely why I have the habit of closing out any contracts I write (calls or puts) for a few cents. I usually close it out somewhere between $0.1 and $0.25... Sure I lose out on that extra $25 or whatever. But I don't want to mess with the price fluctuations in the last 5-30min before close. Especially in high vol envs, or on high vol. stocks.

Let that be a lesson to others following this thread. Don't try to eak out every penny... Be happy when you get a 80%, 90% or 95% of the total value of that trade, and just get out.

I agree with your plan and respect your writings over the years. I just want to clarify something in your words of caution. I agree that closing out early and leaving a small amount of profit is a smart idea because the SP can sometime move unexpectedly just before close and you can get stuck buying/selling shares if your option goes in the money. My situation was different where someone exercised my sold OUT of the money options after close. Is this something you had considered before because I know I hadn't?

 

[adiggs]

When IV goes up, option price goes down

OOPS!!!! When IV goes up, option price goes UP!

Too late to edit, so I'll through this in here. Sorry about any confusion.