"Q&A w/MAC"--selected "Trading and Strategy"
optionstrategist.com
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Rearranged some for ease of reading.
>>> Category: Trading and Strategy Number: 439 12/26/00
Question:
Larry, I am buying leaps and selling current month calls every month. The strategy looks very good. my research shows that this has made a min of 30% annualized over any 2 yr period for the past 20 yrs. Your books which I hold as being the 'bible' shows nothing about this. You talk about selling covered calls, which this is, buying leaps compared to buying the stock and that one call sell calls with a long call as cover. I am looking at this as being of the 'It is too good to be true' type and am even though it is working well, I continuously look for flaws in it. Do you see any flaws or negatives? B.S.
Answer:
This strategy is discussed in Options As A Strategic Investment in the chapter on LEAPS.
There is a fairly theoretical example beginning on page 377.
As with any other bullish strategy (and this IS a bullish strategy), there is downside risk.
The risk is smaller than that of owning stock, in absolute dollar terms, but is greater in percentage terms.
So, it depends on how much leverage you use as to whether or not you get in trouble in a severely, long-term bear market. <<<
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>>> Category: Trading and Strategy Number: 444 2/10/01
Question:
What do you think is the best way to play a long call position for a rebound in the tech/nasdaq sector. I was thinking buying long QQQ in the money calls when the 2004 expirations are available. I know they are more expensive than other options but the risk seems so much less than trying to pick that one particular stock to come back strong. Your thoughts? G.A.
Answer:
2004? I don't generally think that far out in time.
There is nothing wrong with your strategy, except that you are paying a lot of money to be "out" that far in time.
I guess I just don't use LEAPS that much.
I'd rather keep an eye on the chart of QQQ and when it shows some sign of bottoming
-- perhaps by closing above the 20-day moving average
-- then I'd buy QQQ and hold it until it made a new low (or maybe only until if fell below a DECLINING 20-day moving average).
........ At which time I'd sell it and wait until the NEXT time it closed above the 20-day moving average.
There's no way to tell, of course, but I'd bet that the risk from trading QQQ in this manner is probably less than the risk of owning this call, when all is said and done.
Moreover, with my approach, you'll be in near the bottom wherever that may occur.
With the LEAPS approach, you're in at the current strike and that's it -- so if QQQ falls for a year and then doubles, you might not make much money from your call -- but you might from the QQQ purchase strategy.<<<
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Category: Trading and Strategy Number: 360 3/3/00
Question:
I would like to buy LEAP options and sell shorter term options against them using a higher strike price. I suppose this is a calander spread of sorts. Would this strategy be similar to a Covered Call.You would not own the stock outright, but own the LEAPS as collateral.What kind of margin would normally be required and where could I get more information on this subject? G.P.F.
Answer:
The strategy you describe is actually called a DIAGONAL spread, and it has been asked about in other question on this site.
It IS similar to a covered call write, although the delta of the option that is owned is less than 1.0, so the position can actually perform somewhat bearishly near the strike of the written call.
There is no margin required other than the net debit of the options in the spread.
For more information, see the chapter on LEAPS in the book Options As A Strategic Investment.
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Category: Trading and Strategy Number: 229 4/2/99
Question:
What do you think about buying LEAPS calls and selling short term calls multiple times before the LEAPS expire.
What are the advantages and disadvantages of this strategy compared to covered call writing? I have read both your books and the Option Strategist newsletter for over a year and to my knowledge you never describe this method. Does this mean you don't like it? S.R.
Answer:
The strategy you described is covered in Options As A Strategic Investment (3rd edition), pages 377-381.
It is referred to as a diagonal bull spread, but it can be considered a covered call write substitute if you like.
I think the strategy is a reasonable one.
Its main advantage is that downside risk is smaller in case the underlying stock really takes a bath.
The LEAPS strategy has limited risk.
As with any bull spread or covered write, however, profit potential is limited and in this market over the past decade that has been a detriment.
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Category: Trading and Strategy Number: 230 4/2/99
Question:
One big disadvantage of LEAPS seems to be the very large bid/ask spread. What is the reason for this large spread? S.R.
Answer:
The reason that there are large spreads on LEAPS options is that it is difficult for the market makers to price them -- since pricing them involves estimating volatility of a very long period of time.
As in any market, when there is uncertainty (and possibly illiquidity as well), the bid-asked spread widens.
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Category: Trading and Strategy Number: 335 2/28/00
Question:
In McMillan on Options, you discuss using deep in the money options with little or no time value as a substitute for stock; you also discuss diagonal spreads. can you do what amounts to a covered call play by buying a deep in the money call a couple months out and selling an at the money call on a nearby month? B.A.
Answer:
Yes, the strategy you describe is tried by a lot of people.
I'm not sure how successful most feel it is -- especially in this market, where covered writing has cost a lot of people a lot of opportunity. I.e., the stocks have advanced so fast that most covered writers left a lot of money on the table by having written a call against their stocks.
Nevertheless, you CAN try it, especially if you feel that the rate of returns from the strategy (which has more leverage than covered writing) will be acceptable.
In fact, some people buy a LEAPS (long-term) option and try to continuously sell short-term calls against it.
... The position actually has some bearish behavior, especially if the stock is near or just above the strike of the short call at expiration.
... In that case, the position may have a negative delta, especially if the long call has a "lot" of time value premium in its price.
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Category: Trading and Strategy Number: 311 12/18/99
Question:
What do you think about writing covered option calls against your long leaps. Ie. writing the near term month after month and how best to know when to write the calls each month? J.E.
Answer:
This is a strategy that is attempted by most LEAPS buyers at some time, usually with only limited success.
First and foremost, you must realize that you are limiting your upside.
So, if a big move to the upside occurs, you will have to either buy back the written call for a big debit (i.e., loss) or close out your entire spread.
Secondly, knowing "when to write calls each month" is an impossible thing to determine.
...If you could do that, you'd be rich quickly.
Usually, you will find the short-term calls are only expensive for a few months, at most, and then they become cheap.
If you continue to write them when they are cheap, you are not getting any kind of statistical edge at all and will probably find the stock suddenly moving against you.
I think this strategy is basically the same as covered call writing -- except the downside is more limited with the LEAPS option.
Covered call writing is not a good strategy in this current, volatile, market unless you plan to allow the stock to be called away.
Therefore, this LEAPS strategy isn't much better.
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Category: Trading and Strategy Number: 204 7/1/99
Question:
I'm attempting to refine a strategy of buying LEAPS and progressively selling relatively overvalued nearer term options against them with the aims of:
1) limiting risk,
2) minimizing directional bias,and
3) collecting time premium.
This seems to work pretty well when the underlying is trending gently or in a trading range. When the underlying makes a strong move in either direction, however, I get into trouble.
If it goes against me, I lose, but the strategy worked - my assumptions about direction were wrong, but my risk was limited and I exit the trade. More galling is when the underlying moves too rapidly 'in my favor.
I then frequently find myself during the near-term option expiration week with two deep in the money contracts and no profit - sometimes even a loss.
I get the feeling I'm missing something here.
Is it simply that this strategy should be abandoned when the rate of change of the underlying exceeds some value relative to the rate of decay, or is there a disciplined way to reconfigure these positions such that the original aims of the strategy are preserved and I don't have to suffer through watching the buyer of the near-term option eat my lunch month after month? K.R.W.
Answer:
I don't think you're missing anything.
It sounds like you have operated the strategy properly, but you've run into a problem area when the stock rises (nearly every strategy has SOME problem area).
The downside is not a problem, really, except for the fact that you've paid a (fairly large) debit to establish the position, so it is at risk when the market falls. Regarding the upside "problem".
You don't say if you're selling one near-term option for every LEAP that you buy, but I assume that you are.
In that case, you may actually have a position that has a NEGATIVE delta, even though the strategy is ostensibly a bullish strategy. That is, when the stock rises above the strike price of the near-term, written option, that near-term option may have a delta very close to 1.00.
However, the longer-term LEAP, even though it is deeper in the money, will NOT have a delta nearly as close to 1.00.
Hence, the position has acquired a negative delta.
Moreover, the higher the stock goes, that negative delta will continue to remain in place -- robbing the position of profits and sometimes to the point of creating a loss, as you mention.
Furthermore, the short option is probably trading with very little time premium at this point, but the LEAPS option still has a relatively large time premium.
So any time decay or decrease in implied volatility will work against you.
Your question regarding what to do to "fix it" is a difficult one, because there is no fixed answer.
But here are some suggestions.
First, get some option software and graph the position's profit into the future at different stock prices so that you know in advance what is going to happen if the stock moves too much higher.
Second, calculate the composite delta of your position so that you know how "short" you are when the stock rises -- even though the strategy is ostensibly a bullish one.
Also, in that vein, with the software you can monitor the effect that time decay will have on the position.
Third, plan to roll your short option to another month and/or strike price when the position acquires a negative delta or when the risk of time decay becomes overly onerous.
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Category: Trading and Strategy Number: 291 10/21/99
Question:
I've done some research and I like the concept of the bull call spread strategy using LEAPS becuase the stock only has to move a modest amount in order to generate 100%+ profits. Additionally, the longer expiration dates with LEAPS offer a second chance if the stock is in a lull for a while. However, one thing I've noticed about spreads is that you can only make the maximum profit when the expiration date for the spread is near. Is this true? It seems to me that if the stock takes off right after you enter into a LEAPS spread with a two year expiration date that BOTH option premiums would increase and the differential between them may actually decrease. Thus, you would loose if you closed out the spread. Is this true? If so, are there strategies for making significant returns in spreads if the stock happens to "take off" a few months after you've entered into a LEAPS spread with a 2+ year expiration date? I have not read your books yet, so if the answer to my question is in any of your books, just refer me to it and I'll read it. J.J.
Answer:
Yes, you are right.
A bull spread will not widen much in value (unless the strikes are VERY far apart) until expiration approaches. You can see how much it will widen by comparing the deltas of the options.
However, I can't really think of a situation in which a bull spread would LOSE money if the underlying rose in price (unless the markets were very wide, and you lost money due to the bid-asked spread).
This is a problem with selling LEAPS options -- they don't lose time value premium.
So the only way to really profit from a LEAPS strategy when the underlying stock rises is to merely own only the LEAPS call long.
There is a chapter discussing LEAPS strategies in the book, Options As A Strategic Investment.
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Category: Trading and Strategy Number: 211 6/7/99
Question:
I am a subscriber to the "OS" and I find it very useful. I have been looking at a strategy using OEX LEAPS (long) and OEX short term calls which seems to be attractive. I am, however, not sure how a possible assignment would affect the spread, since the OEX is "cash based" and the LEAPS calls and puts have strike prices at 1/5 th of the index. Your help will be appreciated. B.C.
Answer:
Early assignment for the LEAPS shouldn't be any more of a problem than any other $OEX spread, since BOTH the LEAPS and the $OEX options are cash-based.
If you have "true" spread in place, you should be buying 5 LEAPS options for each regular $OEX option that you are selling.
If the $OEX option get assigned early, it will settle for cash and you will just be left long the 5 LEAPS options. You could then go into the $OEX market and sell something ELSE against your 5 LEAPS which you still hold. <<<
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Category: Trading and Strategy Number: 464 6/10/01
Question:
My question is regarding the diagonal LEAPS spread strategy (long LEAPS calls, write near-term calls).
In some of your other replies to this strategy you mention the risk if the stock takes off (especially due to the difference in the delta of the options).
I have a few ideas that I wonder if they could minimize this.
1. Stick to deep ITM LEAPS whose delta is also close to 1
2. Write less short-term calls than LEAPs you are long (example long 10 LEAPs, write 5 1 month calls)
3. Only write the calls when technical considerations say the stock is overextended (such as stochastic greater than 80)
4. Finally, could you not under most cases (exception being when the stock REALLY TAKES OFF) always roll the short calls forward in time and up in expiration at a net credit or extremely small debit.
My reason for doing this strategy is that I am bullish on the underlying in the long-term but see no catalysts for short-term appreciation. M.D.
Answer:
Your suggestions are all good ones.
The first two fall into the category of computing the delta on your net position.
If you calculate the delta of buying a slightly in-the-money LEAPS call and selling an short-term call, you will often find that this position has a negative delta.
Both of your first two suggestions are ways to combat this, and they would work (albeit both at the increase of downside risk).
In fact, if you compute your "position delta" accurately, you may find that buying 10 and selling 7 (or something like that) is the correct number; you can be more accurate than just figuring that "buying 10 and selling 5" won't get you in upside trouble.
As for #3, that's up to you.
Frankly, I not a big believer in stochastics (I guess I've seen too many futures and stocks go through the roof, with the stochastics reading "overbought" all the way up).
#4 is tricky. It will certainly work for a while, but there are plenty of lawsuits stemming from large stock price rises in the last couple of years in which the calls could NOT be rolled up for a credit.
These lawsuits generally arose when someone not familiar with options was "sold" on covered call over-writing by a broker or advisor.
They were generally told that there would not be debits and that the premium from the calls would be extra income.
However, in the big bull market, the "rolling up" eventually got into some fairly serious debits -- mostly as lower strikes were delisted and the advisor was forced to roll up for debits.
The customer then saw that they were "losing money" (not really, of course, but they weren't making the kind of money that they would have if the stock had not been written against) and they sued.
A number of these cases are pending. Thus, you can't be sure that you'll always be able to roll for credits.
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Category: Trading and Strategy Number: 399 7/11/00
Question:
I like to sell calls on leaps I own with little time till expiration how can i tell if the premium is over or underpriced? B. A.
Answer:
The best way is to
1) use an option model to determine the implied volatility of the option under consideration.
... There is a free, no frills model at cboe.com, and
... we also sell our Option Evaluation program for $100.
2) visit the free area on our web site, optionstrategist.com, to check out the volatility history of this stock, index, or futures contract.
You can compare the IV you calculated in step 1 to the historical and implied volatilities shown on our site.
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Category: Trading and Strategy Number: 462 5/10/01
Question:
If someone is long 100 shares of the SPY's (SP500 SPDRS), how can they protect this position, now that the oscillator has issued a sell? 1 put contract on the SPX represents 100 shares of SPX which is equivalent to 1000 shares of the SPY. In essence, I need to create 1/10 contract of the SPX! M.G.
Answer:
You CAN create a hedge for 1/10th of $SPX.
$OEX is about 1/2 of $SPX, and the two perform in a very similar manner.
OEF is an exchange traded fund with listed options that is 1/10th of $OEX.
OAX and OLX are LEAPS options on 1/5th of $OEX.
First, the relationship of $OEX to SPY is 1 contract OEX = 500 shares of SPY.
Hence the OEX LEAPS (1/5th of $OEX) are equivalent to 100 shares of SPY.
But you may not want to use LEAPS options, because of the relatively wide markets and excessive time value premium.
Therefore, consider the OEF options, where 1 contract OEF = 50 shares of SPY.
You can therefore buy 2 OEF puts to protect a 100 SPY position.
The OEF options are not particularly liquid, but there prices are held in line by the "big" $OEX contracts, which are directly arbitrageable by the market makers. <<< |
