2012 YTD rate of return

[hyten1]

 

LOL  your sure fire formula for turning poor results around 180 degrees.  :)

 

But wait a minute.  Let's take a deeper look at what you have said.  Most people buy puts or calls.  They don't write them.  However, most of the time the consistent profits are in writing options, not buying them, because the writer has to accept the risk of a large loss if there is a big move, while the buyer wants to profit from a big move upward or gain protection from a big move downward. 

 

It's like what my favorite insurance company does in insuring against catastrophes.  They make about 20 % per year on their capital on average, by jumping in and writing extra business when rates spike after a big disaster when other insurance companies are licking their wounds and refusing to take on that risk cheaply anymore.  But eventually they will have a bad year, and they and their investors need to be prepared for that.

 

These writers of options or insurance are profiting from the only virtually sure thing in finance: that volatility will always regress to the mean.  ( except when the world ends or the asteroid the size of Manhattan actually strikes Manhattan ).  Those who take on large risks try to lay off their bets in some way by diversification into (hopefully) non correlated risks or hedging, like Eric sometimes does. 

 

The most successful will buy (an option) low (when implied volatility is low or when the potential move in price is very great) and sell (write an option) when the implied volatility is very high or the potential adverse move is very low.  They will also hedge as much as possible cost effectively.

 

By the way, the term, implied volatility, is a misnomer.  It's really a fear factor.  For example, the S& P 500 recently rose about 2% in one day.  Yet the implied volatility of index options actually went down dramatically that day instead of up as the historical volatility of the index increased.  However, if the S&P 500 had gone down a large amount instead of up that day, the implied volatility of its options would have certainly increased.

 

twacowfca,

If I want to write put options on something I would like to own at a lower price, and use the proceedings to invest somewhere else – for instance in something that I like as much, but I consider to be already at a price undervalued enough –, do you know a broker that works also in Italy and that will allow me to do so?

I tried with both Banca Intesa and Unicredit, but I failed… They don’t let me do that on companies listed in stock exchanges outside Italy…

Maybe it’s a silly question, because you don’t know anything about Italy, but you seem a master of the trade, so I try to ask you anyway.  ;)

It would surely be very nice to have some float I could work with!

Thank you very much,

 

giofranchi

 

giofranchi,...

 

you will definitely be able to write put options in real time with "Interactive Brokers"

 

http://www.interactivebrokers.com/ibg/main.php

 

http://www.interactivebrokers.com/en/ibglobal_sites.php

 

 

They also have a multi-currency platform, thus... USD, EUR, CAD... you can have integrated sub-accounts in any currency with your main account. Interactive Brokers are worldwide leaders for option trading. And some board members mentioned that they are also customers. Hope this helps. Cheers!

 

Thank you very much berkshiremystery!

You are always very helpful! And I will check them out asap.

Just one more question:

Do you think they will let me write naked put options, or that they will ask me to cover them with cash? My idea of getting some float to invest doesn’t work, if I must put aside the cash to eventually buy shares at the strike price. Right?

 

giofranchi

 

Gio,...

 

I just asked this question Eric,... because he seems to be with IB,...  ::)

 

so let's wait for his answer,... I'm as curious as you to know this....    ;)

 

 

I know I am not Eric, and I dont deal with IB - TDwaterhouse.  Writing Naked puts requires you to put up collateral.  Say you write puts on a $30 stock for $3 and the puts exercise at $25.00.  You get $3 up front.  If the stock drops you keep using margin, or your cash balance up, ultimately to the price of the underlying stock.  You can start with a net cash position and end up with a margin call very quickly.  The only times I have ever had margin calls is when I have written puts.

 

I gave up this practice.  There are other ways to earn income. 

 

I understand what Eric does and it works for him.  I have no opinion on anything else about the strategy.

 

Collaterl must be cash? Why can it not be shares of other companies you own? If the strike price is low enough and the company is one I would like to own for a long time, I would be glad to sell some shares in other investments, to buy a stake in the company I sold naked puts on.

I know it is not without risk, but, if thought out conservately, I believe it could work.

 

giofranchi

 

gio that is my take as well

 

i have been using put writing as a way to get some cash at the same time i do it on stock that i wouldn't mind owning, especially at these low strike prices that i am writing puts on.

 

 

[hyten1]

i am curious about your statement

 

"However, most of the time the consistent profits are in writing options, not buying them, because the writer has to accept the risk of a large loss if there is a big move, while the buyer wants to profit from a big move upward or gain protection from a big move downward. "

 

just curious on why you say this? I am not saying you are wrong or right, I am just curious as a beginner in options.

 

hy

 

hyten1

 

The psychological underpinning for this dynamic is beautifully described in Chapter 29 on Kahneman's book Thinking Fast and Slow, when he uses the following example:

 

In each of the four examples below your chances of receiving $1mm increases by 5%.  Is the news equally good in each example?

A.  0% to 5%

B. 5% to 10%

C. 60% to 65%

D. 95% to 100%

 

    From an expected value standpoint all four scenarios have equal value.  However from a psychological standpoint, Scenarios A and D are much more valuable (A introduces upside that previously was not there, and D eliminates all remaining downside risk).  For this reason people will gladly pay a premium over the probability value for scenarios A and D.  This dynamic is the foundation the insurance business, lotteries, Las Vegas gambling, lawsuits and countless more.  If you think of written option premiums as insurance that introduces upside, (or eliminates downside risk), Twacowfa's statement will make sense.

 

onyx1, hmm thanks, let me think about this one.

[racemize]

 

Ok, so I was trying to follow your conversation with meiroy, but I think I failed.  I'm just trying to get the mechanics of the above.  First, are you fully hedging your whole position of BAC with the above?

 

1) If they both move up or down in concert, then they offset right?  That still leaves you with the loss on BAC in your original position?

 

2) If BAC drops to 7 or lower, and WFC holds, you get your protection.

 

3) If WFC drops and BAC goes up, you lose? (except your main position has increased, but if you fully hedged, then you'd have a corresponding amount of WFC to deal with)

 

 

On the, "you can go to sleep knowing the most you can lose is 2 dollars", bit, that's only true if they both don't go down a lot, no?  i.e., if they both drop by half, you don't have any protection on your main BAC position since the other two offset each other?

 

I think of options in a more fluid sense - I see it as managing likelihoods.

 

1.  This still leaves you with the loss on BAC original position - if you sell your underlying position at that point.  Selling the puts on WFC is an attempt to avoid having your protection move up and down in concert so if they do, it is more likely to be from Mr. Market and this presents an opportunity to sell profitable put position and buy more underlying.

 

sure, I was just trying to reconcile the statement of "you can sleep at night knowing your loss is at most 7".  To confirm, that sentence is missing "as long as WFC doesn't go down the same amount" I believe?

 

 

This are my original words before you edited out the important part (now in bold):

 

Now you can go to sleep at night knowing that the worst you can lose from your BAC position is about $2 per share.

 

Right, that's what I was referring to, though I misquoted it--it is missing the "as long as WFC doesn't go down the same amount" though?  i.e., if both your WFC and BAC options move down the same amount, they offset each other, leaving you naked on your BAC position, right?  Thus, you can lose more than $2 on your BAC position in that case?  I just want to know what assumption there is in your statement!

[berkshiremystery]

 

 

 

 

I know I am not Eric, and I dont deal with IB - TDwaterhouse.  Writing Naked puts requires you to put up collateral.  Say you write puts on a $30 stock for $3 and the puts exercise at $25.00.  You get $3 up front.  If the stock drops you keep using margin, or your cash balance up, ultimately to the price of the underlying stock.  You can start with a net cash position and end up with a margin call very quickly.  The only times I have ever had margin calls is when I have written puts.

 

I gave up this practice.  There are other ways to earn income. 

 

I understand what Eric does and it works for him.  I have no opinion on anything else about the strategy.

 

Well,.. sure Uccmal,... I know the possibility of a margin call, but anyway... I'm myself in a completely different situation since my US online broker doesn't allow me to hold my Canadian FFH position as marginable, thus only on the cash side of account. So my collateral base seems to be artificially lower, even if it isn't.  Anyway, ... these written puts on AIG,... even if they are currently profitable,... I had them almost forgotten myself,... Hahaha  ;D.  .... you know,... I only tried some months ago to test this option writing technique, because after calling my brokers customer support hotline nobody could give me some sufficient answer. Anyway that was only some toying around,... the nominal value of the "cash on hold" is only 2% of the account equity. So I'm light years away from any dangerous,... at least I got some nice free income while writing these puts

 

I know all those option language terms can sometimes be very confusing,... so at least I try to keep it simple for myself,... always double-check every phrase at my brokers site.

[DCG]

Thanks you

 

I too don't understand what u mean about notional. can you explain what u mean when u say notional and what u thinking when talking about it? Cuz i draw a blank when you use the word and talk about things. I've ur past post about it i can't seem to see it or understand it fully.

 

Also why ?

deep-in-the-money calls

 

I am also unsure of what you mean by Notional.

 

Let's say BAC is trading at $10 a share and you purchase 100 contracts at $1.50 each underlying share.

 

This costs you $15,000 to purchase the upside on $100,000 worth of shares.  $100,000 is the "notional" value of your contracts, even though your downside is $15,000.

 

$15,000 is 15% of $100,000, thus it is 15% of the "notional" value.

 

Clear as mud?

 

Thanks for clarifying!

[Hielko]

i am curious about your statement

 

"However, most of the time the consistent profits are in writing options, not buying them, because the writer has to accept the risk of a large loss if there is a big move, while the buyer wants to profit from a big move upward or gain protection from a big move downward. "

 

just curious on why you say this? I am not saying you are wrong or right, I am just curious as a beginner in options.

 

hy

 

hyten1

 

The psychological underpinning for this dynamic is beautifully described in Chapter 29 on Kahneman's book Thinking Fast and Slow, when he uses the following example:

 

In each of the four examples below your chances of receiving $1mm increases by 5%.  Is the news equally good in each example?

A.  0% to 5%

B. 5% to 10%

C. 60% to 65%

D. 95% to 100%

 

    From an expected value standpoint all four scenarios have equal value.  However from a psychological standpoint, Scenarios A and D are much more valuable (A introduces upside that previously was not there, and D eliminates all remaining downside risk).  For this reason people will gladly pay a premium over the probability value for scenarios A and D.  This dynamic is the foundation the insurance business, lotteries, Las Vegas gambling, lawsuits and countless more.  If you think of written option premiums as insurance that introduces upside, (or eliminates downside risk), Twacowfa's statement will make sense.

While this is an interesting phenomenon it is not the key reason why insurance exists (and writing options - since it is just a form of insurance - is for example profitable). The key reason is that the value of money is not a constant:  the utility of your first million is for example higher than the utility of your second million. You could lose half your money without a serious impact on your living standards, but losing it all would seriously limit how you can life and what you can do. So it makes sense to transfer those kinds of big risks to other parties that have more money and are therefore more equipped to take the risk. This is the dynamic that is the foundation of the insurance industry.

[abcd]

 

Collaterl must be cash? Why can it not be shares of other companies you own? If the strike price is low enough and the company is one I would like to own for a long time, I would be glad to sell some shares in other investments, to buy a stake in the company I sold naked puts on.

I know it is not without risk, but, if thought out conservately, I believe it could work.

 

giofranchi

 

I am sure experts will correct me (if I am wrong). But it is my experience that collateral need not be Cash. But if it is Cash your put writing power increases because your capital is not tied up.

 

For example, if you have $10,000 cash and the margin ratio is 2x (meaning your broker allows you to buy up to $20, 000 worth of shares), then you can write puts up to $20, 000. If you have entered into a position with that $10, 000 then you will be allowed to write puts that are worth $10, 000 only.

[ERICOPOLY]

Right, that's what I was referring to, though I misquoted it--it is missing the "as long as WFC doesn't go down the same amount" though?

 

....

 

Thus, you can lose more than $2 on your BAC position in that case?  I just want to know what assumption there is in your statement!

 

In this case, I deliberated said I can only lose $2 from BAC.  I wasn't being verbose by accident -- in other words, I'm not ignorant to the fact that WFC can drop below $30.

 

I've been down 50% on multiple occasions -- in 2009 for example I was down 50% below my 2008 high at one point, and then again last year I was down 50% at one point off of my early 2011 peak.

 

I'm not trying to protect against that, I'm trying to protect against an event that is specific to BAC.

 

[hyten1]

just spit balling/thinking out loud (i am sure everyone is already know this)

 

so if you have a stock that you have very high conviction of and you think the stock is cheap, very cheap you can

 

1) sell naked put of this stock (at lowe strike price)

2) use the proceed form 1) to buy call on thee same stock

 

if stock drops you can to exercise both 1 and 2 (which you are ok since you think the stock is cheap you would buy anyways)

 

if the stock pops 1) and 2) are both in the money

 

On top of that can't you do this for stock that you like but are not cheap enough now, execute 1 and 2 at decent low strike price or just do 1) are decent low strike price.

 

hy

[racemize]

Right, that's what I was referring to, though I misquoted it--it is missing the "as long as WFC doesn't go down the same amount" though?

 

....

 

Thus, you can lose more than $2 on your BAC position in that case?  I just want to know what assumption there is in your statement!

 

In this case, I deliberated said I can only lose $2 from BAC.  I wasn't being verbose by accident -- in other words, I'm not ignorant to the fact that WFC can drop below $30.

 

I've been down 50% on multiple occasions -- in 2009 for example I was down 50% below my 2008 high at one point, and then again last year I was down 50% at one point off of my early 2011 peak.

 

I'm not trying to protect against that, I'm trying to protect against an event that is specific to BAC.

 

Yeah, so I think I've been pairing this a little differently in my head (figured this out about an hour ago).  I was pairing the WFC and BAC options together and you are pairing the BAC option and BAC position together.  I got stuck in that line of thinking since they were a paired trade, but I see what you mean now. 

 

For explanation, if you think of the WFC and BAC together and offsetting (e.g., if they both move in concert), then you don't have protection from BAC at 7 dollars, since the BAC option is effectively nullified by WFC option.  Conversely, you could say you are protected for BAC, but you are now underwater on the WFC option. 

 

All that being said, I understand that you are protecting against a particular event, and the above is not that event.

[ERICOPOLY]

By the way, the term, implied volatility, is a misnomer.  It's really a fear factor.  For example, the S& P 500 recently rose about 2% in one day.  Yet the implied volatility of index options actually went down dramatically that day instead of up as the historical volatility of the index increased.  However, if the S&P 500 had gone down a large amount instead of up that day, the implied volatility of its options would have certainly increased.

 

I've noticed that too.  Actually, when volatility was peaking in 2008/2009 I started to reason that it wasn't fear, it was greed.  Nobody in their right mind wanted to blow that opportunity to buy things so cheap by tying up their capital writing puts.  Even though the premiums were the best ever, why would you do that when the big money was to be made riding the shares back up.  And what sort of an idiot writes a call at the bottom when he can buy a call instead.  So that drives up demand for the calls relative to supply and makes them really expensive.

 

[beerbaron]

By the way, the term, implied volatility, is a misnomer.  It's really a fear factor.  For example, the S& P 500 recently rose about 2% in one day.  Yet the implied volatility of index options actually went down dramatically that day instead of up as the historical volatility of the index increased.  However, if the S&P 500 had gone down a large amount instead of up that day, the implied volatility of its options would have certainly increased.

 

I've noticed that too.  Actually, when volatility was peaking in 2008/2009 I started to reason that it wasn't fear, it was greed.  Nobody in their right mind wanted to blow that opportunity to buy things so cheap by tying up their capital writing puts.  Even though the premiums were the best ever, why would you do that when the big money was to be made riding the shares back up.  And what sort of an idiot writes a call at the bottom when he can buy a call instead.  So that drives up demand for the calls relative to supply and makes them really expensive.

 

I think you guys are right. If I remember properly it was the bet LTCM had made when it went bust. The market went up, and most of the the time if the market goes up, volatility goes down. The wrote a bunch of put betting the volatility would go down. External events made it happen otherwise.

 

 

BeerBaron