Hi Herm and others,
Long, boring post follows <g>:
I made a program that calculates expected return for various options
strategies a while ago. It assumes that stocks move in accordance with
their volatility. The results for the following hypothetical example
were interesting:
XYZ Corp, priced at $20/share.
Volatility = 50%.
Days to expiration = 45.
(The above are based on typical picks of the "How to.." thread.)
Theoretical (Black-Scholes) price of 20 Call = $1.46
" " " " 22.5 Call = $0.59
I calculated the expected return and chance of profit for four
strategies, assuming zero commission (since it's different for
everyone):
Purchase of $20 call: 34% chance of profit, -$1.15/sh expected return.
No surprise here, call purchases lose money in the long run.
Purchase of $20 call, sale of $22.5 call (bull spread): 40% chance
of profit, $0.05/sh expected return. Not too appealing either,
although a lot better than the plain call purchase.
Purchase of 100 shares, 1 $20 call, sale of 2 $22.5 calls (I call
this a "hybrid strategy, since it mixes the bull spread and covered
call strategies): 48% chance of profit, $0.31/sh expected return.
Looks ok, although the usual caveats about commissions and bid/ask
spreads apply here.
Purchase of 100 shares, sell 1 $20 call: 67% chance of profit,
0.21/sh expected return. What's wrong here? The chance of profits
went up versus the others, but the profits went down. The problem
seems to be that the chance of getting a big gain has been eliminated
while the chance of getting a big loss hasn't.
If the calls are overpriced (let's say that the stock really moves
with 40% volatility but the options are priced with 50% IV), then
the covered call write looks much better, call purchases look even
worse (duh), and the bull spread and hybrid strategies stay roughly
the same. For underpriced calls, (stock moves with 60% volatility)
all strategies suffer except the call purchase.
So, looking at a database that gives historical and implied volatility
(like the one at optionstrategist.com ) could be quite
powerful. Best of all, it's free.
Zach |
