Saturday, January 9, 2010

5 more trading days to pay day

Options involve risk and are not suitable for all investors.  Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options (the "ODD").  Copies of the ODD are available from your broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606.  Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes.  In order to simplify the computations, commissions, fees, and margin interest and taxes have not bee in included in the examples used in this presentation.  These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions.  Investors should consult their tax advisor about any potential tax consequences.  No statement within this presentation should be construed as a recommendation to buy or sell a security or to provide investment advice.

Next Friday is pay day for option writers like me.  It is a known fact that 80% of all options expire worthless, leaving behind their premium with the option writers.

I took a look at the draft option trading plan for January and realized that I did deviate a little from my initial draft.  In my initial draft plan, I wanted to short-strangle GS between strikes 160 and 170.  Before I was able to do that, GS started to show signs of bottoming and a divergence is observed.

I decided instead to short-strangle GS between strikes 160 and 175.  The lower strike of 160 was decided because a bullish divergence is observed around the 160 price level and price started to move upwards.  There is also a very obvious support around 160.

The higher strike of 175, on the other hand, was decided as a level I didn't think GS will reach even with the "pop" from the divergence.  At the same time, selling the 175 strike instead of the 180 strike will obviously give me more premium.

Hence, the short-strangle on GS between 160 and 175.

All is well for the first few trading days.....and the price level stay right smack in the middle of the strangle.  I then decided to sell 3 naked calls at strike 175 for some lousy premium of $0.80 per contract.

Right after doing that, GS really started to "pop" and the divergence started to manifest itself in a powerful way.  The "pop" was a $10 to $12 bucks run in just three or four trading days.  Obviously, the premium for the 175 calls started to gain exponentially as the price continued its advancement.  Now, I'm short in that position and the 175 strike is obviously threatened.  I had to take the defensive action of closing the 3 naked 175 calls at the loss of $492 last Monday without hesitation.  Capital preservation is very important and I have to cut my losses short.  But I also managed to sell some 185 calls and 160 puts and managed to recover most of the losses.

The decision to roll up the 175 call to 185 instead of 180 was to make sure that I won't be compounding on my own mistakes.  I don't want to be in a situation where I have to close off another call at a loss if GS continued to make price advancement.  I want to rule that possibility out completely.  I noted that there was a previously upthrusting action (false breakout) that took place around the 188 price level.  That itself forms a good resistance.  In addition, I also saw the divergence of the Force Index (FI) on the daily and that gave me the assurance that GS will take a breather after the recent run up.  With the "preponderance of evidence", I am convinced that 185 price level will not be breached.

So at this point, there are 5 more trading days before expiration and I'm in a good position.  All in all, I have 16 open contracts on GS alone.  I have other contracts with BAC, JPM, C and WFC as well but obviously GS is where I placed my major bet.  The option greeks for GS based on last Friday's close is also attached.

This is shaping up to be good profitable month for option trading.  With the US$492 realized loss, my profit for January option trading will be less than US$4k.  Well, fortunately I still have fixed income securities, dividends and stock trading to make up for the rest of the monthly target.

The lesson learned is never to add positions in the middle of the cycle (my cycle is always 30 days out as a max) as there will not be enough time decay to buffer you against any sudden move in the underlying.  Add positions only early in the cycle or during the last few days before expiration.  The other minor point here is not to sell calls when you observe a divergence.  You sell calls when you feel neutral to slightly bearish on the market.  You can sell puts below the divergence and support level but not calls, especially naked calls.  Obviously, you can make a guess on where the bullish move will end up but it is certainly not a wise thing to do.

Note:  FI is a powerful short-term (days) custom indicator created by Dr. Elder.  FI takes volume into consideration and is calculated by deducting the previous close from the current close, multiplied by volume.  It answers the simple but important question whether any price advancements or declines are accompanied by volume or not.


randomjaywalking said...

Can you include the position greeks as screenshots?

dream said...

yes, sir. it is now included.

randomjaywalking said...

your position theta is greater than your position delta so it looks good going into the final week of options expiry... this is the powerful effect of time decay.