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Old 09-21-2007, 11:47 AM   #1
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options help

Now that the VIX has settled down a bit, and the market is rallying, I'd like to buy some deep OTM puts on SPY.

So, how do I go about it?

If the volume is essentially zero at the strike I want, will my order still get filled? (Are there market makers in options?)

I assume it would be nutty to place a market order, so should I calculate the "correct" price for the option and place a limit order?

Is it safe to assume that the price for a LEAP vs a short-term option is rational? I.e., that buying a series of short-term options should be about the same cost as going out further with a LEAP given the same implied volatility?

I'm not going to make a huge bet, so I don't mind paying for an education, but I would prefer a free or cheap education.
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Old 09-21-2007, 12:32 PM   #2
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Quote:
Originally Posted by twaddle View Post
Now that the VIX has settled down a bit, and the market is rallying, I'd like to buy some deep OTM puts on SPY.

So, how do I go about it?

If the volume is essentially zero at the strike I want, will my order still get filled? (Are there market makers in options?)
Yes, there are market makers, and there should be a bid-ask shown for the various strikes even if they haven't traded today. If the bid-ask isn't shown on the trade screen you can always call your broker, and he will call the floor to get the bid-ask.

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I assume it would be nutty to place a market order, so should I calculate the "correct" price for the option and place a limit order?
I would definitely use a limit order. You can calculate a theoretical price for your own information to get an idea of the implied volatility. Just remember that the further OTM you go with a put, the higher the implied volatility will be. It's not constant across strikes.

Quote:
Is it safe to assume that the price for a LEAP vs a short-term option is rational? I.e., that buying a series of short-term options should be about the same cost as going out further with a LEAP given the same implied volatility?
No. The volatility grows with the square root of time, so the pricing isn't linear with time.
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Old 09-21-2007, 01:28 PM   #3
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Thanks, FIRE'd. Excellent info as always.

Looks like Ameritrade shows bid/ask in 0.05 increments, which is crazy for the OTM options. They have a built-in calc that shows implied volatility and theoretical value. Theoretical value doesn't start to converge on the ask until you get close to in-the-money options.

If I bet on a 25% decline sometime in the next 6 months, for example, it looks like I'd win 100X my bet if a crash happens on Monday. Seems like winning the lottery would be more likely and would pay better.
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Old 11-29-2007, 03:40 PM   #4
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Another options question:

When one writes in-the-money covered calls, how is it determined when the shares are called away?

Is it just a random lottery? Are the sold calls assigned to a specific buyer (and the shares are called away when that buyer exercises the option)? Does it get matched within the brokerage first, and then somehow distributed via the exchange?

Mostly I'm just curious, but if I wanted to sell some stock and capture a little ITM option premium, is there any way to increase my odds of having the stock called away sooner rather than later?
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Old 11-29-2007, 03:57 PM   #5
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Another options question:

When one writes in-the-money covered calls, how is it determined when the shares are called away?

Is it just a random lottery?
AFAIK it is just a random lottery, so there isn't a way of gaming the system.
My personal experience is that deep in the money can can get exercised very early. For instance early this year I wrote Intel $10 Jan 08 call while buying $10 Jan 09 calls, with the intention of unloading the losing position in Dec. The stock was exercise in Nov, 10 weeks before the expiration.
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Old 11-29-2007, 06:56 PM   #6
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twaddle,

I'm on the road right now, but if you're interested, I'll post the title and author of a book that I have that covers only covered call writing. While I don't do covered calls myself (as I don't own individual stocks, only mutual funds), if I did, I think I'd be writing covered calls, and using that book as a fundamental reference.

Um, that is, I'll post them after I return home...
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Old 11-30-2007, 09:55 PM   #7
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Well I'm back at home and in front of the computer, so...

Stocks for Options Trading, by Harvey C. Freidentag

It's all about covered call writing.
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Old 11-30-2007, 10:06 PM   #8
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Thanks, TT. Google has the entire book online so I was able to search through it. It doesn't seem to cover the bit of exchange arcana I was looking for, but it does look like a good reference.
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Old 11-30-2007, 11:17 PM   #9
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Hmmm...

Sure-Thing Options Trading by George Angell may cover that particular arcana. Or maybe a different work by Angell.
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Old 12-01-2007, 01:21 AM   #10
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On the random exercise question, there are both European and American-style options:
  • A European option may be exercised only at the expiry date of the option, i.e. at a single pre-defined point in time.
  • An American option on the other hand may be exercised at any time before the expiry date.
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Old 12-05-2007, 12:13 AM   #11
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Yes, it's random. The OCC assigns exercise blocks to brokerages; the brokerages then decide which customers get the notices.
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Old 12-05-2007, 06:45 PM   #12
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I assume it would be nutty to place a market order, so should I calculate the "correct" price for the option and place a limit order?
Yes, it would be nutty to place a market order when the volume is low or zero. I've done it (when I used to do options) but only on high volume options. Worked out ok, but it was a roll of the dice.

The "correct" price is given by the Black Scholes formula, and I think most brokerages calculate that for you, I know that ETrade does.

Option prices are a combination of strike price (intrinsic value), volatility, and time premium. As FIRE'd said, time premium goes with sq rt of time, and for an OTM LEAP this will be a significant amount of the price -- but time premium won't change much until you get closer to expiration. Same for intrinsic value, a deep OTM put doesn't have much intrinsic value, but if the mkt starts dipping, and starts coming close to the strike price, the intrinsic value starts paying off, which is the whole reason to buy a put. Volatility, well, as you noted, it's best to buy when volatility is down.

It's a good idea to start small, to learn. I assume these will be puts on SPY you already own -- married puts. I'd stay away from naked puts, or naked options of any kind -- leave that to the pros. It's the best way to lose all your money except perhaps for penny stocks. No, actually, it's even a better way to lose all your money than pennies -- it can happen in hours vs days.
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Old 12-05-2007, 08:44 PM   #13
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I assume these will be puts on SPY you already own -- married puts. I'd stay away from naked puts, or naked options of any kind -- leave that to the pros.
He is planning to buy the puts, not sell them. There is no such thing as a "naked buy". Unless of course he is standing in his den while makes his order, having forgotton to don his robe.

Ha
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Old 12-05-2007, 09:57 PM   #14
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He is planning to buy the puts, not sell them. There is no such thing as a "naked buy". Unless of course he is standing in his den while makes his order, having forgotton to don his robe.

Ha
Well, ok, technically it's not a married put, since he would not be buying both the SPY and the puts at the same time. But he does want to buy the puts, ie, buy a contract that gives him the option to sell the SPY at a given strike price within a certain time period. Whomever is on the other side of that contract sells the put to him, which gives him the cash but forces him to accept the SPYs at the strike price, at the buyers' option. It's been years since I've traded options and it's getting late, but I think this is how it works. If not, I'm too lazy to go back and reconstruct my memory.

Oh, and by "naked buy" I meant buying the put without owning the underlying SPY. The naked buy you refer to would be a "nekkid buy."
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Old 12-05-2007, 10:08 PM   #15
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Well, ok, technically it's not a married put, since he would not be buying both the SPY and the puts at the same time. But he does want to buy the puts, ie, buy a contract that gives him the option to sell the SPY at a given strike price within a certain time period. Whomever is on the other side of that contract sells the put to him, which gives him the cash but forces him to accept the SPYs at the strike price, at the buyers' option. It's been years since I've traded options and it's getting late, but I think this is how it works. If not, I'm too lazy to go back and reconstruct my memory.

Oh, and by "naked buy" I meant buying the put without owning the underlying SPY. The naked buy you refer to would be a "nekkid buy."
No, the buyer of a put has the right, but not the obligation, to exercise it and buy the underlying at the contracted strike price.

Whatever happens, the buyer's max loss is the premium that he pays when he buys the put.

Ha
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Old 12-06-2007, 07:28 AM   #16
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No, the buyer of a put has the right, but not the obligation, to exercise it and buy the underlying at the contracted strike price.

Whatever happens, the buyer's max loss is the premium that he pays when he buys the put.

Ha
OK, thanks for the correction. As I said, it's been at least 10 years since I last did options, and have tried to put it out of my mind. The last two I did were OTM LEAP calls on AOL and puts on QCOM, both of which expired OTM.

I also wrote some covered calls, but eventually discovered this only works in the long run with a stock that has an up trend, and hopefully you get called, buy-write again at a higher price, etc. With a declining stock you keep the premium but it's a one time thing, and if you keep writing eventually you get called at a lower price and take the loss.

Sometimes I think of taking a small amount of money, say 1% of my holdings, and just buying some calls as a gamble, but if you make money, it's like crack. So I think I will just say no and stay with my diversified index funds.
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