Technical Trading Strategies

[deonb]

If I only understood how that worked...

Jeff

Basically it works like this:

My example uses 1 put and 1 call contract, where each contract is 100 options. The expiration date is Jan 2015, and the current ask on those calls are $13.30, and the bid on those puts are $17.10. (You tend to get better than this on both sides when you actually place a bid).

a) You sell a put ("sell to open") with cash-secured or margin funds to the value of the put. E.g. for a $55 strike put, the broker will secure $5500 of your funds (or margin) until you buy the put back. The act of selling the put will net you $1710. ($17.10 x 100)
b) You buy a call ("buy to open") with the money you made from the put. That will cost you $1330 ($13.30 x 100).

So you net $380 out of the deal. So now you basically just secured 100 TSLA shares for $5500 (the cash-secure) - $380 = $5120. That works out to $51.20 per share.

And the risk/reward profile it is the same as for shares.

Let's take scenarios at the point of expiration (Jan 2015):

a) TSLA is at $50. You put will get assigned (you'll be forced to buy for $55). So your broker uses your $5500 of secured funding to buy 100 TSLA shares for $5500. You own the shares, but you can only sell them for $5000. So you're out $500 - same as if you were to buy 100 shares now and the price drops to $50.
b) TSLA is at $55. Both your put and your call expires worthless. You get your secured funding back. You're neither up or down. Same as if you were to buy 100 shares now at $55 and it stays at $55.
c) TSLA is at $60. Your put expires worthless, and your call is worth $5. You get your secured funding back. You can either exercise the call using the secured funding (pay $5500 for $6000 worth of shares), or sell the call outright for $5 x 100 = $500. You're up $500 either way. Same as if you were to buy 100 shares now at $55 and it goes to $60.

And you can at any time close the position by selling the call and buying the put, and the same as above will hold true (for the most part). If there is a temporary spike in the price you can also just buy the put (for cheap) while holding onto the call. That takes out your downside risk completely and releases your secure funds back to you.

Of course there is no free lunch. The market robots surely won't pass up an inefficiency like this? After all, TSLA for $51.30?? Correct. What you don't get with options is the interest if you were to lend out the shares (if your broker does that). However - that interest rate might drop in a week when shorts give up all hope (hopefully). If that drops, the price of puts will drop accordingly.

A "risk" you have is that the puts will be exercised prematurely if the price drops significantly. So you may end up owning 100 extra TSLA shares that you didn't necessarily want. But that again would be the same as if you were to just buy the shares outright and the price drops.

Hope this helps!

 

[CyberDutchie]

Deonb,

Thanks for the explanation. I actually did this play today, or at least I thought I did, but made one big mistake. :redface: In stead of "sell to open" put I did a "buy to open" put. How would I reverse this, "sell to close" the put followed by another "sell to open" put?

I'm a newbie at this as you can tell. Just bought 1 call and 1 put, so damage done is minimal (I hope).

 

[Norbert]

What you don't get with options is the interest if you were to lend out the shares (if your broker does that). However - that interest rate might drop in a week when shorts give up all hope (hopefully). If that drops, the price of puts will drop accordingly.

I think you also can't use the options as a collateral in a margin account. (Still learning.)

Hope this helps!

Thanks for all the little extra info you put in there.

 

[mershaw2001]

Deonb,

Thanks for the explanation. I actually did this play today, or at least I thought I did, but made one big mistake. :redface: In stead of "sell to open" put I did a "buy to open" put. How would I reverse this, "sell to close" the put followed by another "sell to open" put?

I'm a newbie at this as you can tell. Just bought 1 call and 1 put, so damage done is minimal (I hope).

Going in and out of options is much worse than stocks. The bid/ask spread for options is usually horrible, for stocks it can be a few pennies but for options you're looking at a dollar on some of these high cost puts. However, there are hidden buyers/sellers in the spread. That means that if the bid is 11.00 and the ask is 12.00 for this put, there is probably someone who will take you out of the trade for 11.30 or someone who will buy the put for 11.80, even though he/she isn't listed.

If you're happy with your call, which it sounds like you are, then you do exactly what you said: sell to close, and then sell to open. I do think you might be able to "sell to open" two and save yourself the commission. (I do this when i want to reverse a position, close and open at the same time. It makes it look ok in your account, however, it is possible that your brokerage retains a +1 put and a -2 put, which runs the risk of allowing the put holder the ability of prematurely assigning you the shares and catching you off guard. In that case, you'd just call your brokerage and assign the +1 put on the same day.)

Ok so back to the bid/ask spread, you can lose a significant chunk if you don't probe between the bid and the ask. When you want to sell these puts, put a limit order up for the ask price. Then cancel and change it 10 seconds later to 0.10 less. And then repeat as you walk your way down to the bid price. It takes a minute or two and 10 orders but you can get like 0.50 or more out of it.

 

[CyberDutchie]

Ok so back to the bid/ask spread, you can lose a significant chunk if you don't probe between the bid and the ask. When you want to sell these puts, put a limit order up for the ask price. Then cancel and change it 10 seconds later to 0.10 less. And then repeat as you walk your way down to the bid price. It takes a minute or two and 10 orders but you can get like 0.50 or more out of it.

Thanks for the tip, I should buy you a beer at the Dutch Goose, or a coffee at Peets :smile: