Please help this fool!

Discussion in 'Investing' started by Maverick83, Feb 7, 2021.

  1. Maverick83

    Maverick83 New Member

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    Hi all, I hope you are all doing great.

    I recently thought of this option traiding strategy and since I have a smooth brain, I was wondering if anyone can find flaws with this tactic so I don't lose all my investment before I go into real market action with this strategy.

    The strategy is to use poor man's covered call and covered put at the same time on the same stock. If the stock tanks to the bottom or rockets to the moon, the loss on either put or call would be offset by opposite side. So, why would I want to do this zero sum tactic? Because I am after the option premiums I would be selling every week or bi-weekly. In order for this to work, I would have to choose a stock with medium to high volatility rather than low volatilty so the option premiums are higher.

    For example, let's say I'm going to invest 10k on a stock ABC, current price @$50 per share. I'd buy 2 of $30 strike price call option at $25 which will expire in a year, and I would also buy 2 of $70 strike price put option at $25 as well. Then, I'll be selling 2 of a week long short call option with $55 strike price @$1.5 per share, and also sell 2 of week long short put option with $45 strike price @$1.5 per share.

    If stock price stayed within the strike price and both short options are OTM, then I would profit $600/week, giving me $2,400 profit /mo with just 10k investment. If one side hits strike price, then I would buy to close the one hit the strike price and leave the other side of call option since it is not going to be ITM within the same week most likely. In that case, I would've not make any money in that week (or lose a bit from the premium), since the price of the short call or put will be sitting around $3-4. However, in most cases, even very high volatile stocks should have longer stabilized period than the period where it takes extensive movement. If the stock moves drastically in either direction, I buy back the short calls/puts then wait until stock price stablizes again. Then sell my long call/put (whichever the side that gained value) to profit from that movement. I would leave other side of long option alone (even if it is OTM) since there's a good chance it would come back to ITM zone. Re-position my long calls and puts then get back in the game.

    From rough calculation, I would lose about 30-40% if I held both call and put long options near expiry date (If stock price remained within $30-$70 threshold) because I would lose money on time value, but I would've already made more than enough within first couple months from selling the premium. If the stock were to skyrock or tanks, I would actually make money from my long calls or puts as well. Let's say if the stock price skyrocketed to $100 per share. I would've lost money on my $70 put call, but the long call at $30 would offset all the loss from $70 put call and still leave me a bit of profit. Vice versa if the stock price tanks to $10.

    So, only way I'd be actually losing money is if short option sale does hit the strike price every single time, or even worse, both call and put options hit the strike price within the same week or two, which is almost impossible.

    Please let me know if there's anything else I should consider, as I'm just getting into the option trade. Like I said, I have smooth brain and need smarter people's input to make shre this is fool proof :). I'd really appreacite any input. Thank you.
     
  2. StockJock-e

    StockJock-e Brew Master
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    Collecting premium is a valid strategy that works well in the long run.

    Start off small, test it out!
     
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  3. Maverick83

    Maverick83 New Member

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    Thank you for the response. I was hoping to understand what are the chances of changes in IV creating bigger loss than anticipated?

    More specifically, this tactic is based on when the price moves in either direction, the long call/put option on the opposite side would conteract the loss that occured because of the price movement. Is such case as, I lost money on my long put option because the stock price went up, but my call option did not move up as much as anticipated so my call option cannot cover most of loss occured on the long put option. Is same IV used on both call and put?
     
    #3 Maverick83, Feb 7, 2021
    Last edited: Feb 7, 2021
  4. StockJock-e

    StockJock-e Brew Master
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    IV is tricky, if there is too much IV in your option, the stock going sideways, or even slightly in the direction it needs to go can end up with you NOT making money because there was too much IV to begin with.

    Its a weird and wonderful aspect of options that you will get hit with often!
     
  5. spindr0

    spindr0 Active Member

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    There are a lot of moving parts in this strategy so the short answer is that you need a quality charting program to see the what ifs. Several thoughts:

    Nothing is foolproof with options except arbitrages.

    This strategy will get clobbered if implied volatility contracts sharply.

    I suspect that you made up these prices because it's hard to believe that one week options that far OTM would have such high premiums.

    Ignoring IV change, you will lose money if the stock moves to the extremes ($30 or $70) because one of the near term short options will go to 100 delta and the two LEAPs will not offset each other enough to remain profitable.

    You're also assuming that you'll be able to sell $600 in premium every week. Not gonna happen. Plus, you may be buying back 100 delta losses on short ITM one or two week short options because you don't want to be assigned.

    On the plus side, if the stock moves up, you can roll the profitable long $30 call up, booking gains and lowering risk, at the cost of long delta. The same holds true for the long $70 put if the stock drops.

    My best suggestion is to paper trade this for several months. With complex strategies, you need to understand the what ifs before hand and formulate your adjustment strategy if the position gets in trouble. You don't want to be the deer in the headlights trying to figure out what to do as it's happening.
     

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