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Old 11-20-2011, 08:44 PM   #121
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Originally Posted by FIRE'd@51 View Post
So you estimate that, if SPY is 118 at the close on Nov 25, the calendar spread will be worth 1.70. At what price of SPY do you estimate that the calendar spread would be worth 2.37? How about on the upside? That is, at what price of SPY above 122 at the Nov 25 close, do you estimate that the calendar spread would be worth 2.37?
The spread will be worth ~2.37 if SPY is at 119.25 or 124.75. Not coincidentally, there's about a 50/50 chance that SPY will be inside that range.
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Old 11-20-2011, 09:14 PM   #122
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Utrecht is the basic principal here that since monthly option is priced at ~2x a weekly as predicted by B-S, selling 4 weekly will make twice as much as a selling a single monthly?

This of course assumes that market is flat. However the market has been basically flat for the six month which is why the strategy has worked out so well. I think when I return from visiting my mom in Dec I will switch from writing slightly out of the money monthly calls and puts (a short strangle) to weeklies

I would point the reason the strategy has done so well when you back tested it for 7 years (correct?) is that in 2004 the SPY was between 1120 and 1200. Thus we have had 7 or (10+ actually) years of a flat market. BTW you should be including dividends in your calculations vs holding SPY. Looking at the SPY chart, I would guess that except for late 2008 when selling weekly puts would have been very ugly and the 2009 rally, this strategy would outperform the SPY by a good margin.

The obvious trick of course is to be smart/lucky enough to stop selling puts when the market crashes. I'd be interesting in seeing your data from 9/2008 through 2009.
Not exactly. First of all, this SPY calendar spread is more of an experiment than anything else. The premise is that time decay works more quickly the closer the option is to expiration so the flatter the market is the more valuable the spread will be as the price of the weekly option deteriorates quicker than the monthly will.

The spread will be profitable at the end of the first week if SPY doesn't move more than 2.25% in either direction. Theoretically, there's a 50/50 chance that the spread will be profitable at the end of the first week so I don't believe that this will be profitable by trying to do it in a mechanical way. However, I do believe it can be profitable over the long term if you monitor the spread and close it at the right time. The right time could be on the third day, or it could mean buying back the weekly, selling next weeks weekly and closing it sometime next week. If the spread is moving against you, the longer you hold it, the tougher it will be to recover so its definitely something that needs to be monitored.

As for the mechanical system of selling naked puts, it will obviously outperform the market by a larger amount the flatter the market is, but I believe it will out perform the market in EVERY market condition other than short periods when it is moving sharply straight up. It outperformed in 2009 when the SP500 was up over 26%. It made money in 2008 when the market was down over 37% or "crashed" as you said. It MADE money in 2008, not just outperformed the market by losing less than the market did. Did it make money during the worst 2-3 months of 2008 when the market dropped off a cliff? No, but over the entire year it did.

I really don't see why this is so hard to believe. People buy puts as a hedge or insurance against taking huge losses. These puts are more expensive than they are worth. Over the long term, these people would be better off not buying the puts. They may save them from a big loss in any given week or month, but over the long term, they cost more than they save the buyers. Whoever is selling the puts to them is profiting just like Allstate does selling car insurance.
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Old 11-21-2011, 01:44 AM   #123
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I really don't see why this is so hard to believe. People buy puts as a hedge or insurance against taking huge losses. These puts are more expensive than they are worth. Over the long term, these people would be better off not buying the puts. They may save them from a big loss in any given week or month, but over the long term, they cost more than they save the buyers. Whoever is selling the puts to them is profiting just like Allstate does selling car insurance.
This is my basic theory also. I'd argue that much like Warren Buffett is happiest writing catastrophic insurance polices after a bad hurricane year than after a few good years, the best time to sell portfolio insurance is when people are fearful and the memory of loss is still fresh. I like how efficient it is to write insurance on stocks, no need to hire agents, buy expensive building etc. Of course, I don't buy insurance on virtually anything.

On the other hand it is worth remembering that AIG Financial products along with bond insurance companies like MBIA, AMBAC, had a terrifically profitable business writing was basically portfolio insurance for holders of all kinds of bonds, MBS, CDOs, and Muni etc. It was a great business until it wasn't.
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Old 11-21-2011, 06:24 AM   #124
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As for the mechanical system of selling naked puts...................

I really don't see why this is so hard to believe. People buy puts as a hedge or insurance against taking huge losses. These puts are more expensive than they are worth.
This is what I have been trying to say throughout this thread. The source of any long-term alpha is solely the result of the puts being overpriced. Without this systematic overpricing, selling naked puts would theoretically be expected to underperform a B&H over the long-term because the put seller does not participate in the upside (right side) of the underlying stock's probability distribution in excess of the put premium, while fully participating in the downside (minus the put premium). When you say "these puts are more expensive than they are worth", you are implicitly saying that the implied volatility (and, hence premium) of the puts you sell is greater than the subsequent experienced volatility (the stock's probability distribution is narrower than what you paid for). I attempted to calculate the magnitude of this effect in posts number 91 and 94, and came up with the result that, for weekly puts, this alpha is about 2.9% annually (before commissions) per one percentage point of excess implied volatility.
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Old 11-21-2011, 07:33 AM   #125
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I'm not saying they are overpriced systematically, as in someone miss-prices them every week because their formula is wrong. I'm saying that someone who buys them is paying more than they should long term for insurance. Just like most people will pay much more in car insurance over their lifetime than they will collect by having wrecks and getting money paid out to them.

Clifp, your "it works until it doesn't" is a good analogy. That's why I don't sell naked puts on individual stocks. That would be like insuring one individual driver. If he has 1 or 2 wrecks, I would take a beating, but by insuring every driver, I cant help but come out ahead. The insurance prices already have a profit figured into them.
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Old 11-21-2011, 05:36 PM   #126
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This is what I have been trying to say throughout this thread. The source of any long-term alpha is solely the result of the puts being overpriced. Without this systematic overpricing, selling naked puts would theoretically be expected to underperform a B&H over the long-term because the put seller does not participate in the upside (right side) of the underlying stock's probability distribution in excess of the put premium, while fully participating in the downside (minus the put premium). When you say "these puts are more expensive than they are worth", you are implicitly saying that the implied volatility (and, hence premium) of the puts you sell is greater than the subsequent experienced volatility (the stock's probability distribution is narrower than what you paid for). I attempted to calculate the magnitude of this effect in posts number 91 and 94, and came up with the result that, for weekly puts, this alpha is about 2.9% annually (before commissions) per one percentage point of excess implied volatility.
I went back and reread post 91 and 94 and I finally understand what you are saying. (Hey I got a D the first time I took Differential Equations and boundary value problem ) Yes and I agree the actually volatility is significantly lower than implied volatility of the options which is why the strategy is working so far. 3% Alpha is pretty nice.

My rational is that unlike 9/11 or the Fall of 2008, there really hasn't been any fundamental changes to the market that justify the crazy daily swings we have been seeing. The market is just very nervous and people are expecting/fearful that it will crash or in some cases take off. It is hardly news or unexpected that Europe will be (not) dealing with debt problem, and partisan gridlock will prevent any progress on the US deficit reduction. Yet the VIX at over 30 is predicting some major movement, when the most likely result is a muddling through on both sides of the Atlantic.
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Old 11-25-2011, 03:00 PM   #127
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Someone double check my math here because this doesn't seem right.

I had to make a trade earlier than I normally would've have because I am out of town on vacation and everyone wanted to go to the beach.

I bought back the weekly 122 put for 4.58 and then sold next week's 117 put for 1.94. Normally I would've waited and ended up selling the 116. My original cost was 2.37. Since I spent 4.58 and collected 1.94 today. That adds 2.64 to my cost basis making my total cost basis 5.01. I could close the trade right now for 5.14. That's whats throwing me off. It doesn't seem like I should have a profit.

Basically I have a SPY 122/117 calendar put spread which I paid 5.01 for and is worth 5.14? Something seems amiss.
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Old 11-25-2011, 05:05 PM   #128
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Someone double check my math here because this doesn't seem right.

I had to make a trade earlier than I normally would've have because I am out of town on vacation and everyone wanted to go to the beach.

I bought back the weekly 122 put for 4.58 and then sold next week's 117 put for 1.94. Normally I would've waited and ended up selling the 116. My original cost was 2.37. Since I spent 4.58 and collected 1.94 today. That adds 2.64 to my cost basis making my total cost basis 5.01. I could close the trade right now for 5.14. That's whats throwing me off. It doesn't seem like I should have a profit.

Basically I have a SPY 122/117 calendar put spread which I paid 5.01 for and is worth 5.14? Something seems amiss.
I'm not sure why you are surprised the position would be showing a profit at this time?

Your original position was:

Quote:
I sold 10 Nov25 Weekly 122 Puts for 2.07 each
I bought 10 Dec 122 Puts for 4.44 each.
Total debit of 2.37.
The way I see it - since you paid (went long) more for the further out monthly Put than you received in credit for the other Put (obviously, since they are the same strike the further out one will have a higher price), the over-all position is weighted to the 'long' side on the Put. Since Puts go up in value as the underlying drops, and SPY has dropped from ~ 122 to ~ 116 in this time, I would expect the value to increase.

Does that make sense?

-ERD50
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Old 11-25-2011, 06:06 PM   #129
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Someone double check my math here because this doesn't seem right.

I had to make a trade earlier than I normally would've have because I am out of town on vacation and everyone wanted to go to the beach.

I bought back the weekly 122 put for 4.58 and then sold next week's 117 put for 1.94. Normally I would've waited and ended up selling the 116. My original cost was 2.37. Since I spent 4.58 and collected 1.94 today. That adds 2.64 to my cost basis making my total cost basis 5.01. I could close the trade right now for 5.14. That's whats throwing me off. It doesn't seem like I should have a profit.

Basically I have a SPY 122/117 calendar put spread which I paid 5.01 for and is worth 5.14? Something seems amiss.
Your math seems right to me.

I think your original estimate that the long 122 puts would only be worth 5.70 with SPY at 118 may have been too low (did you take into account the dividend?). Additionally, the VIX increased 2.5 percentage points over the past week, so your long 122 puts held their time premium better than you anticipated.
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Old 11-25-2011, 06:25 PM   #130
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I used the options calculator at CBOE when I quoted prices for the options if SPY finished the week at 118. The calculator showed that the trade would be profitable with SPY ending the week anywhere from 119.25 to 124.75. This is what I'm talking about when I say that options don't act in real life as they seem like they should on paper.
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Old 11-25-2011, 06:39 PM   #131
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I used the options calculator at CBOE when I quoted prices for the options if SPY finished the week at 118. The calculator showed that the trade would be profitable with SPY ending the week anywhere from 119.25 to 124.75. This is what I'm talking about when I say that options don't act in real life as they seem like they should on paper.
What inputs did you (or they) use for volatility and dividends until expiration?
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Old 11-27-2011, 10:34 AM   #132
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Those fields are already filled in. The volatility number was whatever the VIX was at that time (around 32). I don't remember what the dividend number was but i assume it was correct.

According to the calculator now, the trade will remain profitable if SPY ends the week anywhere under about 119.5.
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Old 11-27-2011, 11:08 AM   #133
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If you mean this option calculator it gives me a put price of 6.42 (not 5.70) for a 32% volatility if I use a strike of 122 and an SPY price of 118 and 21 days until expiration.
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Old 11-27-2011, 12:13 PM   #134
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OK, then assuming I looked at the calculator incorrectly when I posted last week, this trade would've been profitable ( according to the calculator) at the end of the first week if SPY ended the week anywhere from 117.75 - 125.85. According to the probability calculator at OptionsHouse, there is a 62% chance of SPY moving those percentages in one week. So if these two calculators are correct, you could make this trade the first week of every option cycle and expect to make money long term without regard to the state of the market.

Now, we already saw in real time that SPY ended at 116.34 ( a good chunk below the 117.75 predicted by the calculator) and the trade is still profitable so obviously the calculators are estimates and dont take into account other variables that occur in real life.
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Old 11-27-2011, 12:48 PM   #135
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Now, we already saw in real time that SPY ended at 116.34 ( a good chunk below the 117.75 predicted by the calculator) and the trade is still profitable so obviously the calculators are estimates and dont take into account other variables that occur in real life.
I would say it somewhat differently. One of the inputs to the calculator changed over the past week - i.e., the VIX increased by 2.5 percentage points, reflecting increasing options premiums, all else equal. Had the VIX stayed the same (or decreased) the trade would show an unrealized loss at an SPY of 116.34. It's sort of like trying to predict what the price of a Treasury bond will be next week. There is nothing wrong with the model that the price equals the present value of the future coupon payments. It's just that the rate used to discount those coupons is itself a random variable.
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Old 11-27-2011, 01:05 PM   #136
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Except that if SPY drops from 122 to 116.34 or 4.6% in one week, then you can be sure the VIX is going up. Its a virtual certainty but the calculator doesn't use that info.
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Old 11-27-2011, 01:21 PM   #137
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Except that if SPY drops from 122 to 116.34 or 4.6% in one week, then you can be sure the VIX is going up. Its a virtual certainty but the calculator doesn't use that info.
Not necessarily. Even in a world with a truly constant volatility of 30%, there is about a 13% chance that SPY will drop at least 4.6% in a week - about the same probability as flipping three heads in a row with an "honest" coin.

In any case, the calculator gives a numerical sensitivity to changes in an input variable (e.g. the volatility) for traders who wish to try to hedge against those changes, or at least better understand the risks they are facing.
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Old 11-30-2011, 11:38 AM   #138
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Well, I learned one thing. This calendar spread doesnt like getting whipsawed.
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Old 11-30-2011, 01:57 PM   #139
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Well, I learned one thing. This calendar spread doesnt like getting whipsawed.
Yes, but the people on the other side of your trade LOVE it!

I'm hoping SPY settles down near $123 or lower by Friday close, or my calls will cap my gains this week.

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Old 11-30-2011, 03:23 PM   #140
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Has anything changed in options since Peter Lynch said not to do them?

See One Up On Wall Street, copyright 1989, page 278. An introductory excerpt from his discussion:
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There's no point describing how futures and options really work, because (1) it requires long and tedious exposition, after which you'd still be confused, (2) knowing more about them might get you interested in buying some, and (3) I don't understand futures and options myself.
I think he knew more then he admitted.

P.S. I own a bunch of SPY. Based on longish term trading that has "seemed" to work since the 1930's. But too boring for the Wall St crowd. I mention this because I'm fine with taking timing risks if they make money.
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