Exotic Trade Note

As some may recall, a few weeks ago I was putting on option strangles in the daytraders’ darling, FAZ.

In a couple of different accounts I had sold puts and calls against this vol monster, and they were working pretty well.

In July, for example, in one account, I had gone long the stock, and short $18 calls (double the stock shares) and short the $16 puts (equal the number of long shares).

Time decay has been doing its thing, and the position is looking pretty good, even with the calls going into the money today.  I picked up around 4 points per share in time premium when I put the trade on, so I’m not losing money at expiration unless the stock is north of $22 or $23 a share.

The more interesting aspect of this stock is the huge premium for longer-dated options.  I just sold another set of puts and calls for January, which will come faster than I can imagine if the passage of the last six months is any indication of my revised temporal sense.

The net premium collected from selling Jan $20 calls and Jan $18 puts in matched amounts was $10.50 per share, after commissions.  That leaves me with a pretty wide window of profitability — from $7.50 up to $30.50.

I do worry a little about the potential for the stock trading north of $30 by January, but after the July series expires, maybe I’ll buy a few shares outright so I end up slightly biased toward the up-in-price side of the trade.

We’ll see.



4 Responses to Exotic Trade Note

  1. Egor says:

    Suggested consumer advisory: do not try this at home.

    If you are buying and selling against a 2x / 3x synthetic there is _not_ a simple base “stock” in play. The ETFs in question employ leverage and do not provide exact correlation to the underlying.

    The options have known time decay while the ETFs have unknown (to the investor) theta. IOW, there are exceedingly complex variables _and_ unknowns in play so … buyer (seller) beware.

    I suspect you know of what I speak (err, type) Howard … though your readers may not. Naked time sensitive positions against levered products have risk (and reward) in extremus.


    ps – you position is probably fine, but others may make costly mistakes trying to emulate same

    • hhill51 says:

      Thanks for that caution. I’ve tried saying that over and over again, but it never hurts to repeat.


      Do not try this at home unless you understand every word of Egor’s comment (above). Even then, paper trade first, and ALWAYS figure out what could make you lose money, and how you will exit and/or neutralize the risk if the trade goes against you.

  2. Steve Meyer says:

    I think your idea is good because it is not clear how to calculate
    the expected relation of option price to underlying index price
    so fundamental intuition should be an advantage.

    My question is since you are selling straddles why not use the
    3x long FAS since it has more volume and more option volume.
    Put call parity should still hold.

    • hhill51 says:

      Good question and observation.
      First, I chose FAZ over FAS because the lower dollar price allows the option premium to span a larger range of prices at expiry.
      Theoretically should not be true, but the FAS Jan 2011 options trade to implied vols in the mid-90’s while the FAZ option chains were pricing to 106% to 108% implied vol when I put the trade on yesterday.
      The second reason is stubbornness. I bought the FAZ to hedge when I thought the rally since last March had gone one direction only for too long. I was early — so early some would say “wrong”.
      By stubbornness I refer to a characteristic of successful traders I have known – they HATE to lose money, so they try to figure out how to make money after even small losses. In this case, I saw the initial position go underwater and didn’t like it, so I sold covered calls. Then I legged into negative basis vertical spreads. Then I looked at building a book of sold vol across several time frames.
      According to the accounting on ThinkOrSwim (option traders’ broker, for sure), I’m now up a few thousand dollars year to date on the position.
      If prices were to stop moving right now, that would turn into five figures of profit, even though the position never took more than $10K in cash or $25K in capital reserve.

      You’re absolutely correct that intuitive understanding of the second and third derivative type option costs (common in mortgage land) helps play this monster.
      It probably confounds most straight equity players, but with 60 million shares or more most days, the action is heavy enough for me to jump in between the legs of the elephants to snatch a few dollars.

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