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Strategies & Market Trends : Options 201: Beyond Obi-Wan-Kenobe -- Ignore unavailable to you. Want to Upgrade?

To: Uncle Frank who wrote (3)	8/10/2001 7:07:15 PM
From: Dan Duchardt	Read Replies (2) \| Respond to of 1064

Uncle Frank, Thank you for pointing out my blunder. I posted the correct link, so perhaps a few more folks will find their way here now. I see that others have commented about Roth's suggestion related to selling strangles on cc4d. I agree that the "bullish outlook" is a bit perplexing, but I think I can make some sense of it, at least for myself, and I will try to do that here. As for what McMillan thinks, I must confess that I have never read his work. I heard him speak once, and I know that has a well deserved reputation for being the master of options trading. My not reading him is not out of disrespect, not is it that I think I know better or cannot learn from others. It is a matter of knowing myself and the learning style that works best for me, which is to grapple with the issues on my own and see where it takes me. When I hear other people quote McMillan, or Roth, or anyone else, if it makes sense to me that's great. If not, or if it sounds contrary to what I think, I immediately re-examine my own thinking. I really like the idea incorporated by Roth that selling a strangle is two positions: a conventional covered call and a short put. The put can be naked, backed only by minimal margin requirements, or it can be cash backed as suggested by one of the posters on the cc4d thread. Regardless of what is backing it up, there is risk from the moment you sell a put. If the market goes down, the value of that put is going up, eating into your net worth, and the farther down the stock goes the faster the value changes. Any short put is a bullish strategy. It may be that you are content to own the stock at the net price it will cost you if assigned, but only if you are convinced that it will ultimately go higher, at least to the strike price you wrote. The same can be said of a CC of course. Even if you expected a near-term decline, and wrote ATM to somewhat ITM calls, you do so believing that you own (or are buying in conjunction with the call write) a stock that will come back to higher levels after the decline. If that were not the case, you would be better off selling the stock. So I think it's safe to say that the covered strangle strategy is bullish in the longer term, though you could argue that neutral to bullish as opposed to very bullish would might be more appropriate. Roth's view that it is strategy for a "very bullish" outlook I think rests on two important factors. First, let's not forget that Roth is talking about LEAPS strangles, not near month strangles. His time horizon is at least 6 months out. As the position evolves, the time value decay of the options is going to be extremely slow. Second is the observation (fortunately I do have a copy of Roth, so i could look this up) that all of Roth's examples are an extension of his treatment of covered straddles. All of his straddle examples involve ATM LEAPS, and all of his strangle examples are symmetric, i.e., the call strike is one level above ATM and the put strike is one level below ATM. When you combine these two things, you recognize that if the stock starts to drop, your investment is going to drop in value initially nearly dollar for dollar with it, and accelerate to as much as two dollars lost for every dollar decline. If the sock is down 7 bucks, and you are already down 12 or so, you might start getting really nervous about your trade ever being profitable. I'd say that to hold on to such a position you would need great confidence that it was going to reverse the downtrend and come back at least to the lower strike you can realize a little profit. I'd say you would have to be very bullish to hang in there. Roth does not address it, but the strikes can be adjusted for a more bullish to more timid view. The put could be sold ATM with the call two (or still just one if you want) strikes above to raise the cap, or the call could be sold ATM with the put two (or one) strike below if you are neutral. He might use different words to describe the outlook needed in those cases. Dan

To: Uncle Frank who wrote (3)	8/10/2001 10:58:26 PM
From: BDR	Read Replies (2) \| Respond to of 1064

<<What is McMillan's impression>> Well, Frank, if you insist on listening to the opinions of an accredited writer in the field instead of anonymous posters on internet threads (g), here is what I found. He doesn't specifically address whether a straddle is bullish or not in the chapter on the subject, but one can infer his position from what he says about the components of the straddle. The following are excerpts taken from the chapters of the same titles. Re- Covered Call writing: "The writer should be mildly bullish, or at least neutral, toward the underlying stock. By writing a call option against stock , one always decreases the risk of owning the stock. It may be possible to profit from a covered write if the stock declines somewhat." Re- The sale of a put: "As might be expected, the seller of a put will make money if the underlying stock increases in price...It is a bullishly oriented strategy." Re- The sale of a Straddle: "The covered sale of a straddle is very similar to the covered call writing strategy and would generally appeal to the same type of investor." Ergo, I conclude it is a mildly bullish strategy. As Dan has pointed out, if one is very bearish about a stock's prospects, why risk riding it down in return for a small premium? Just sell the stock. Furthermore, he goes on to say: "The similarity between this position and a covered call writer's position should be obvious. The covered straddle write is actually a covered write - long 100 shares of XYZ plus short one call - coupled with a naked put write. Since the naked put write has already been shown to be equivalent to a covered call write, this position is quite similar to a 200-share covered call write. (His italics) In fact, all the profit and loss characteristics of a covered call write are the same for the covered straddle write. There is limited upside profit potential and potentially large downside risk." (This is beginning to sound less mysterious than I thought) As Dan has suggested the potential rate of loss as the stock price falls is greater: "The covered straddle writer loses money twice as fast on the downside, since his position is similar to a 200-share covered write." Hmmm. I don't recall that aspect of the position being prominently discussed on the other thread. Figure 20-1 Shows the Profit or Loss at Expiration graph for a covered straddle write compared to covered call write and the downslope to the left is steeper for the straddle, meaning that losses mount faster as the price at expiration falls. I think this is what Roth was saying when he described the position as "more intense" than the stock.. Above your breakeven the profits are greater than for just a covered call but below the breakeven your losses are also greater. (Dang, there is always a catch) Now that I understand it better, a covered straddle is simpler than I thought it was when it was first presented on the other thread. But it is also clear that the increased potential profitability is accompanied by risk of greater losses. It isn't a panacea. dale@quotingandnotthinking.pov