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Old 11-30-2011, 05:48 PM   #141
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Well, I learned one thing. This calendar spread doesnt like getting whipsawed.
This is not intended to be a criticism because I know you were on vacation and probably couldn't do a thorough analysis. A lot of times I roll the short ITM put keeping the strike the same. IOW, with the VIX increasing last Friday, you probably could have rolled the 122 weekly put out another week at the same 122 strike and taken in 0.30 - 0.40 in time premium, which would have reduced your cost to 1.97 - 2.07 and not exposed you to the whipsaw, yet still left you with two more chances to own the 12/17 put for free.
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Old 11-30-2011, 09:17 PM   #142
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Yes, I think that would've been a better move. It would've changed the whole idea of making a mechanical trade though. This trade still may get a chance to recover though. We went from WAY oversold to WAY overbought very quickly and my guess is the market finishes the week lower than where it is now.
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Old 12-02-2011, 06:14 PM   #143
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I'm curious which weekly puts you sold today in your calendar trade. I would have sold the 122's for about 85 cents. Even though you could get more premium by selling the 124 or 125 strike, you would be exposing yourself to a downside whipsaw to 122.
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Old 12-02-2011, 08:34 PM   #144
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I did sell the 122's and you were right, I should've sold the 122s last week as well. When I first thought about making a trade like this, the idea was to just stay with the same strike and sell weekly puts 3 times against the one monthly put that I was long (there is no point and making a 4th weekly trade if I'm using the same strike). I got confused and made a trade that wasn't what I intended to do.

If I had made the trade that I had intended to make in the first place, right now I would have the following:

Long Dec 122 Puts....Worth 1.73
Short Dec9 Weekly puts...Worth 0.87

Original cost of the trade was 2.37 and I would've sold last weeks 122's for ~.35 and this weeks 122s for .85

Total cost basis 1.17 and the spread is worth 0.86 right now.
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Old 12-04-2011, 08:31 AM   #145
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I did sell the 122's and you were right, I should've sold the 122s last week as well. When I first thought about making a trade like this, the idea was to just stay with the same strike and sell weekly puts 3 times against the one monthly put that I was long (there is no point and making a 4th weekly trade if I'm using the same strike). I got confused and made a trade that wasn't what I intended to do.

If I had made the trade that I had intended to make in the first place, right now I would have the following:

Long Dec 122 Puts....Worth 1.73
Short Dec9 Weekly puts...Worth 0.87

Original cost of the trade was 2.37 and I would've sold last weeks 122's for ~.35 and this weeks 122s for .85

Total cost basis 1.17 and the spread is worth 0.86 right now.
Hang on a second. I misread what Fire'd@51 wrote when he said I could've (should've) rolled out the 122s last week for .30-.40 in premium.

I now realize that he meant .30-.40 on top of what it cost me to buy back the current weeks 122's (option calculator shows it to be more like .60). meaning that the total trade would've looked like this:

Week 1
Bought Dec 122's for 4.44
Sold Nov25 Weekly for 2.07. Cost basis 2.37

Week 2
Bought back Nov25 Weekly122 for 4.58 and sold Dec2 weekly122 for ~5.15. Cost basis 1.80

Week 3
Dec2 Weekly 122 expires worthless. Sold Dec9 Weekly 122 for 0.85. Cost basis is 0.95

Position is currently worth 0.86.
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Old 12-10-2011, 07:28 AM   #146
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Closed out this trade yesterday. I lost money because I screwed the trade up, but here is the trade when done correctly.

As of last week the cost basis was 0.95. The weekly expired worthless and the monthly (with one week left) sold for 1.14 for a total profit of 0.19.
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Old 12-10-2011, 04:32 PM   #147
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This has been an interesting thread. Thanks, utrecht, for sharing your thoughts, research, and trades with us.

Here is a relevant article from the Personal Finance section of today's WSJ:


Options for Nervous Investors

By JACK HOUGH

Stocks have generated more worry than gains this year—and for more than a decade. Yet slim yields on bonds and savings give stockholders little enticement to sell.

The result for many investors is an unlovely combination of high fear and low reward.

There is one way to steady a stock portfolio without unloading shares, however: an options strategy known as "covered calls." The idea is to collect extra income now in exchange for giving up potential gains later.

Research suggests investors who use covered calls can turn the risk-reward trade-off in their favor by using a strategy based on stock indexes rather than individual stocks.

First, some terminology. Calls are option contracts that can give buyers an inexpensive bet that a stock will rise above a specified "strike price" before a specified date. A call "writer" collects the price of the bet (the "premium"), but might have to deliver the shares if the stock tops the strike price. He's "covered" if he already owns the shares.

"Puts," by contrast, offer buyers protection against a stock decline. Put writers collect a premium—but, like insurers, writers might have to pay if disaster strikes.

Depending on the strategy, calls can be used to reduce risk (covered call-writing) or to add staggering amounts of risk ("naked" call-writing), so brokers issue options-trading permission only selectively.

Call writers should have no advantage over call buyers. "If you write a call on your IBM shares, you reduce both risk and potential return, one for one," says Bob Whaley, a Vanderbilt University professor who in 1993 developed the Chicago Board Options Exchange Market Volatility Index, or VIX, which tracks investor expectations for market volatility.

Indeed, mutual funds that used options for either speculation or hedging from July 2003 to June 2007 showed no sign of market-beating returns after adjusting for risk, according to a working paper by Gjergji Cici, an assistant professor at the College of William and Mary. He says there is limited research on the subject because the historical data are "a mess."

One type of option might offer more opportunity than others, however. Some researchers say a quirk related to index options, like those written against the Standard & Poor's 500-stock index, offers investors a way to reduce risk without giving up much in return.

At least nine research papers since 1990, from academia and Wall Street, have shown that index options are often overpriced—an opportunity for those who sell them.

In the options world, contract prices are directly related to the volatility of the underlying securities. That is how the VIX works: An investor who knows the prices others are paying for options on the S&P 500 can calculate the volatility those investors expect.

With individual stocks, this "implied volatility" tends to match pretty closely with actual volatility over long time periods. That suggests neither buyers or sellers have a predictable price advantage.

But the VIX overestimates the broad S&P 500's future volatility more than 80% of the time, according to Josh Parker, president of asset manager Gargoyle Investment Advisor.

There is a good reason. Institutional investors have ravenous demand for index puts, since they offer cheap protection against a market crash, Mr. Parker says. All that buying pushes index put prices higher—and call prices, too, because the two move in tandem. That suggests an investor who writes index options is getting a better price than one who buys, on average.

In 2001, Vanderbilt's Mr. Whaley developed an index to exploit the high price of index options. It is called the CBOE S&P 500 BuyWrite Index, or BXM, and it simulates owning the S&P 500 and writing covered calls each month. "It aims for stock-like returns but bond-like volatility," says CBOE vice president Matt Moran.

Over 10 years through November, the BXM returned 4.2% a year, versus 2.9% for the S&P 500. Over 20 years, which counts the go-go 1990s, its lead is narrower: 8.4% versus 8.3%. During both periods its volatility was significantly lower than that of the S&P 500.

Investors can buy into the BXM index through the PowerShares S&P 500 BuyWrite Portfolio, an exchange-traded fund, or the iPath CBOE S&P 500 BuyWrite Index, an exchange-traded note. Both were launched in 2007, so real-world return histories are limited. Also, both cost $75 a year per $10,000 invested, plus trading commissions. That is enough to more than offset the 20-year outperformance of the index, which suggests investors should view these as volatility reducers, not return boosters. (CBOE has other BuyWrite indexes that aren't yet tracked by ETFs.)

Such funds perform best when stocks are flat, says Ilya Figelman, an analyst with AllianceBernstein. Investors shouldn't overestimate the safety they confer, since they only slightly outperform during a crash, he says.

Then again, an investor who can't take risk shouldn't be in the stock market in the first place, Mr. Figelman says.

—Jack Hough is a columnist at SmartMoney.com.
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Old 12-10-2011, 06:23 PM   #148
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Wow, some smart guy and I agree on something!
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Old 12-10-2011, 07:03 PM   #149
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Ah you just beat me in posting that great article. My headline was going to be "Utrecht you are a genius" LOL

When I looked at my YTD performance I was struck by the difference in performance of my taxable accounts around 7% vs 2.7% for IRA. The portfolio composition is different MLPs in my taxable account, more bonds (which did well this year) in the IRA. But I own a mix of individual dividend stocks, and various index funds in both accounts. However, the big difference was that I wrote close to 300 contracts in my taxable account and only a few dozen in my IRA.

Now obviously a flat year for stocks with high volatility in last 6 months of the year has been the ideal time to write calls and puts. Still the returns for the roughly 25% of my taxable portfolio (i.e. the margin allocated) which I've been writing options has been outstanding.

The thing I learned form Utrecht is that despite my inclination to write options on individual issues you are actually much better off writing options on the indexes because the are over priced relative to the true volatility of the market.
I suspect that index calls are also overpriced and so the short strangle trade has been a good one, Utrecht it is something you might want to consider looking into.

The question I'd like to discuss is assuming Utrecht's back testing and 9 research papers are correct and index options are mispriced is why are they mispriced and are likely to remain so?

My hypothesis is that are structural reasons relating that causes a greater demand for index options than supply and hence they are overpriced.

The biggest problem with option writing is it is tax inefficient so I'm going to be restructuring my portfolio so that I'm going buy 1000 SPY and maintain a cash equity position in my IRA so that I can write 10 SPY at the money calls (they have to be covered in an IRA) and 10 SPY Puts each week.
I am going to be ret
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Why are index options overpriced.
Old 12-10-2011, 07:42 PM   #150
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Why are index options overpriced.

This is just a working hypothesis please feel free to shoot holes in it, especially you folks who have actually worked on wall street.

If index options are overpriced then logically this is because the demand for them exceeds the supply. This caused me to start to wonder well why is this the case.

When I thought about money managers who write index calls the only group that seem to do this on a regular basis is managera of buy write funds like those discussed in the article. In my experience these funds tend to be close end funds, like ETV and ETJ with assets in the 500 million and 1 billion ranges.

On the demand side there are insurance companies which issue investment like Equity Index Annuities. As Brewer explained these investment typically consist of zero coupon bond and call options on indexes. My guess is that there is more money invested in insurance products than in the Buy-Write funds.

Actively managed funds and hedge funds are probably other large suppliers and consumers of index options. I have no idea if on net they tend to write or buy more options.

Finally we come to individual investors. I feel pretty confident that individual investor are more likely to purchase call options than write them.
So while Utrecht trades have been impressive to this group, if he is at cocktail party, telling people that I risked $125,000 to make $1500 this week, sounds a lot less impressive than the guy on the other side of the trade who can brag that he bought $1500 weekly option that is now worth $10,000 (While neglecting to mention that for the last 8 weeks it expired worthless).

Moving to the market for put options. I am hard pressed to figure out what institutions are systemic writers of put options. I know that Warren Buffett has written them especially long term ones. In contrast, it is easy to see why there would be a demand for put options. Money managers for pension funds and such I am sure often want to purchase puts in order lock in their profits for a period of time. Their objectives are typical doing well enough that the client does not fire them, not trying to maximize returns. Likewise I individual investors who are bearish would be purchasers of puts, as well as folks buying portfolio insurance.

Now mind you this pretty much pure speculation.
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Old 12-10-2011, 11:11 PM   #151
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Now obviously a flat year for stocks with high volatility in last 6 months of the year has been the ideal time to write calls and puts. ...
It wasn't for me. A flat year means nothing if there were some big spikes up that cap your gains for that period. You BTC the option at a loss (or let it be assigned, and buy the stock back at a higher price). If those losses on the buybacks exceed the other premiums you received, B&H would have been better.

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Old 12-11-2011, 07:26 AM   #152
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If you think back to 1987, institutional investors practicing portfolio insurance were badly burned trying to synthetically create index puts by adjusting a short futures position (i.e. dynamic hedging). They then wised up and began to purchase index puts even if they had to pay up for them. By doing so, at least they knew upfront exactly what their insurance cost would be. Because institutional investors typically hold broadly diversified portfolios, they buy index puts because they cost less than puts on individual securities. They want to insure against market risk, not individual security risk. Also most think (incorrectly?) that they can pick stocks that will outperform the market.

Personally, I like writing puts on individual securities as a form of targeted buying. I only write puts on stocks I want to own. I'm not trying to collect alpha here so I don't care that the puts aren't overpriced - I just want to own the particular stock at a lower price. If I don't get assigned, I still collect the premium, which turns out to be a great annualized return. Clifp, I believe this is your strategy as well.

With regard to buy-write funds, most typically sell calls on individual securities because this brings in more premium. They don't really care if the stock gets called away since this gives them the maximum return for that particular trade, and they tend to be absolute return investors.

The article is saying that there is some alpha in selling index options. However, it does not follow that a covered-call (or cash-secured put) strategy will outperform the index over the long-term. The alpha may not be large enough to beat B&H over time. It just means that, if this overpricing persists, the index option writer will benefit relative to the index option buyer.
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Old 12-11-2011, 08:51 AM   #153
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Up to date returns for selling weekly naked SPY puts

Real time last 30 weeks

Naked SPY puts....+13.9%
SPY.....................-9.8%

YTD including back test for Jan-May

Naked SPY puts......+22.7%
SPY.......................+1.7%
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Old 12-11-2011, 08:56 AM   #154
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We moved the thread to the stock picking forum because it is not general interest and will suggest to members that future discussions on options be located here as well.

Cheers...
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Old 12-11-2011, 05:52 PM   #155
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If you think back to 1987, institutional investors practicing portfolio insurance were badly burned trying to synthetically create index puts by adjusting a short futures position (i.e. dynamic hedging). They then wised up and began to purchase index puts even if they had to pay up for them. By doing so, at least they knew upfront exactly what their insurance cost would be. Because institutional investors typically hold broadly diversified portfolios, they buy index puts because they cost less than puts on individual securities. They want to insure against market risk, not individual security risk. Also most think (incorrectly?) that they can pick stocks that will outperform the market.
Good explanation I wasn't too clued into what was happening back in 1987, just remember selling my Magellan fund the Friday before Black Monday and seeing that by the time the order cleared I got out at the bottom

Quote:
Personally, I like writing puts on individual securities as a form of targeted buying. I only write puts on stocks I want to own. I'm not trying to collect alpha here so I don't care that the puts aren't overpriced - I just want to own the particular stock at a lower price. If I don't get assigned, I still collect the premium, which turns out to be a great annualized return. Clifp, I believe this is your strategy as well.

With regard to buy-write funds, most typically sell calls on individual securities because this brings in more premium. They don't really care if the stock gets called away since this gives them the maximum return for that particular trade, and they tend to be absolute return investors.

The article is saying that there is some alpha in selling index options. However, it does not follow that a covered-call (or cash-secured put) strategy will outperform the index over the long-term. The alpha may not be large enough to beat B&H over time. It just means that, if this overpricing persists, the index option writer will benefit relative to the index option buyer.
Yes that is my strategy for buying individual stocks, beside the significant benefit of collecting premium, I like the use of options because it prevents me for overpaying. For example if I like ABC at $50 and I see it is trading at 50.20 I'll probably put an order at $50.15, if it never hits the limit price, the next day it may climb to 50.60 and I'll raise the order to 50.55. A few days latter I'll have chased all the way up to $53 before I catch it.

However, the insight I've gotten from Utrecht, this thread and reading the WSJ article, plus googling some of the papers on index options, is index options are overpriced. My initial reaction when I started to see VIX go through the roof in a flat market is that I'd be better off writing individual puts than index puts. I figured (I think somewhat logically) that the collective premium for 500 individual puts (appropriately weighted) on the S&P would be greater than premium on the index options.

It turns out I am wrong and Utrecht's comments were right.

Quote:
I do trade spreads on individual stocks. I only sell naked options on an index. Trading spreads is less risky than trading spreads but since an index will generally move less than individual stocks do, Im OK with the extra risk from selling naked options. You could go broke on one really bad naked options trade on a volatile stock but indices just dont move as much so I prefer not to pay for the extra protection by buying the option that makes up the other side of the spread.
Let me illustrate with an example. MSFT has a beta of .98 (close enough for government work to be 1). It is currently trading at 25.70 or almost exactly 1/5th the SPY at 126.05. The implied volatility (IV) of at the money MSFT puts is around 22.4 vs an IV of 24.2 for the Jan SPY 126 put.

If I wrote a strangle selling 5 MSFT Jan 25 puts and 5 MSFT Jan 26 calls, I'd collect $5.75 in premiums and I'd make money if MSFT traded between 23.85 and 27.15. The equivalent trade for the SPY is a selling a 125 put and 130 call, this would give me $5.67 and I'd make money if the SPY end between 119.33 and 135.67.

Now if we forget the math for moment it is relatively easy to envision scenarios that we cause MSFT stock to drop below $20 or rise above $30 in the next 5 weeks and turn my $575 of profit into a $2500 loss. A general market rally/decline, a tech sector rally or decline, and host of company specific announcements. It is much harder to think how we will see S&P 1000 or S&P 1500 in the next 5 weeks. Sure it could happen but it is far less likely than MSFT stock rising or dropping 20%. Yet the premium that option writers are getting is the same for these two. Now perhaps the index options are fairly priced and the individual options are underpriced. However, I suspect that index options are overpriced.

While you are right that there is no guarantee this strategy will outperform B&H of the S&P. For the SPY trade I just outlined if no major news happens in the next 5 weeks, it is certainly likely that the S&P will stay between 1200 and 1350 and I'll make a small profit and if it says between 1250 and 1300 I'll be making almost 1% a week. If we do this on monthly basis I can afford a few time when the market moves against. Adopting Utrecht weekly options trades looks even better. Potentially another idea would be to buy long term strangles on individual issues to hedge against major market moves, plus you could get lucky when the oil platform leaks, insider trading scandal happens, or the take over is announced.

All in all this has been a terrific and so far profitable thread.
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Old 12-17-2011, 08:43 AM   #156
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Ive been selling weekly SPY puts on the day of expiration for 8 weeks now. I sell the first strike below SPY and do it 30 minutes after the market opens. I take in an avg of 0.3% but of course it depends on how high above the strike that SPY is trading.

The total return for buying SPY at 9:00 CST and selling at the close on every Friday for the last 8 weeks is -1.31%. The return from these puts is +0.72%. Not including commissions.

I'm sure someone will tell me that this wont work either but believe me the time value gets sucked out of these things so fast it cant help but outperform SPY unless the market shoots straight up every Friday after the first 30 minutes. I purposely wait to avoid any gap openings up or down

PS..I'm pretty sure selling strangles will work even better.
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Old 12-17-2011, 09:26 AM   #157
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Ive been selling weekly SPY puts on the day of expiration for 8 weeks now. I sell the first strike below SPY and do it 30 minutes after the market opens. I take in an avg of 0.3% but of course it depends on how high above the strike that SPY is trading.

The total return for buying SPY at 9:00 CST and selling at the close on every Friday for the last 8 weeks is -1.31%. The return from these puts is +0.72%. Not including commissions.
Interesting. Of course, SPY B&H is up 1.775% over the past 8 weeks, not including commissions/fees (oh, that's right, there aren't any).

Yes, I know, your money is free the rest of the time to make other investments (edit: but you also have to have the cash available to cover those puts on that day, so you may have to get out of other investments in order to do that trade, or you are not fully invested and that has consequences also). I just threw that out there for some perspective.


Quote:
I'm sure someone will tell me that this wont work either ...
There's really no reason to be so defensive. I'm not saying that anything won't 'work', I'm just skeptical that anything like this will provide significant excess reward/risk, before the market would gobble it up. That is my (semi-educated) opinion, nothing more. But I am very interested to be proven wrong and learn something in the process, and I'm very interested in following any strategies that appear to do so.

But like is often said, many things will 'work', until they don't.


Quote:
but believe me the time value gets sucked out of these things so fast it cant help but outperform SPY unless the market shoots straight up every Friday after the first 30 minutes. I purposely wait to avoid any gap openings up or down
And my viewpoint is - the 'market' would not consistently by buying these with 'excess' time value, every Friday like clockwork. My opinion is that the time value is pretty commensurate with the risk. Again, if this money was just there for the taking, I think the big boys (and/or their computers) would be buying it up before we could reach for our keyboards. JMHO.


Here's an interesting thing that happened to me a few months back - I had 115 and 116 calls on SPY. My routine is to BTC and roll out if it looks like they will be assigned. Within a half-hour of close on the Fri exp, SPY was bouncing ~ 115.80. I rolled out the 115s, and watched closely, but SPY stayed below 116, so I just (intended to) let the 116 expire, and I'd sell the next calls on Monday, or the next 'up' day. Market close was 115.85, so I figured I was fine. But, the calls were assigned. Turned out the market rose above 116 after the close, and option holders can request an assign for some time after the market close. Now, the person on the other side could have only made a few cents per share on that, and I assume he went short SPY to null out any risk of even a small gap Monday AM. So this was a truly riskless trade for them. Just an example of how 'the market' gobbles up opportunities. And something to watch out for, for anyone who was unaware of that rule.

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Old 12-17-2011, 10:09 AM   #158
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The 8 Fridays that I'm talking about actually covers 7 weeks because it starts with a Friday and ends with a Friday. It covers from 10/28/11 thru 12/16/11. B&H SPY is down 5% during that span, not up 1.77%. This is an apples to oranges comparison to what I'm talking about so I'm not sure why you even brought it up. If you want to make a comparison, we can compare the SPY B&H -5% return to the SPY weekly naked puts return of -3.15% during that same time frame. Once again, selling puts beat the market in a random time frame. Again, the only time selling puts like this doesn't beat the market is when the market is moving sharply straight up, but selling puts still makes money during that cycle so I'm fine with it. Basically, when this strategy "works until it doesn't work", I'll still be making money. Not a bad problem to have.

I didn't realize that an option could be exercised like that after the close so thanks for that info. Ive never had that happen to me.

How about you discuss your options strategies?
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Old 12-17-2011, 04:33 PM   #159
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Ive been selling weekly SPY puts on the day of expiration for 8 weeks now. I sell the first strike below SPY and do it 30 minutes after the market opens. I take in an avg of 0.3% but of course it depends on how high above the strike that SPY is trading.
Do you no longer sell weekly puts? Market open is not exactly a convenient time for me 3:30 AM half the year and 4:30 the other half.

I also have a question regarding how to handle the situation where the SPY is right around the strike price in the final hour.

To use ERDs example if I am short a SPY 116 call and SPY closes at 116.2
How long do I have to deliver SPY shares? and what is the best way to handle this?
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Old 12-17-2011, 04:59 PM   #160
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Yes, I sell the weeklies every Friday (and hold for a week), but have also started selling what I call a "daily" put. Its a weekly but I sell it the day of expiration.

I wouldnt call myself an authority on options assignments at all. I can only remember getting assigned one time and it was years ago. I just don't let it happen, although lately Ive begun to think about that subject. I assume in your example the shares will be deducted from your account over the weekend.

If I am short a 125 put and SPY is at 124.95 within minutes of the close, I have to buy back the put (or roll forward which still technically is buying it back). The problem is that the price wont be .05. It will be more like .15 and sometimes more like .25+ if I need to make the trade earlier for some reason. The whole point of selling these puts is to make money as the time value ticks away and I dont want to lose out on any of it. I haven't put a lot of thought to it yet, but I was considering shorting SPY in a case like that. Wont that lock in my price and be the same as if the market closed at that minute?

In other words, I dont think I would be subject to any price changes after that. If SPY rallies, my short put makes a bit more money but my stock loses money and vice versa. I break even. If SPY closes below 125, doesnt the stock that gets put to me just cancel out my short shares?
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