Originally Posted by Mark Vierra
On a personal note, I've been attentively following options.
Trying to get a feel for the price action.
I've come to a preliminary conclusion that reaffirms the "there are no free lunches."
It looks to me that you really have to be spot on in time and strike to have any meaning for someone like me.
I can see how daytraders can make out pretty good, but no saving grace for an under 25K account.
However, I am still entertaining the SPY put as a hedge for my remaining longs, but see that I should wait until
price comes to my 1540 comfort level and the order I have for the 1-lot UPRO to sell at 111$ (1/3 of my remaining position).
That way I'll have better price, time and odds that a correction will (I hope) make a winner out of the insurance policy.
A correction could happen at any time but If my plan goes well I think in a few weeks to mid-April for
mid-term highs to be put in and an optimal time to buy a put if the market does correct henceforth.
I've noticed an imbalance in call/put option price and wonder,
Does this mean there are more traders that think the same as me and there will be a correction is why puts are more expensive than calls?
Options are subject to supply and demand, right? Or the MM will write as many of whatever you want like candy out of their pocket?
There's no way I'm going to shell out more than 200$ for a put so I've been looking at exp. time/strikes accordingly.
Maybe put prices won't be as attractive as I think as the market continues higher because of increased demand/bets on a correction.
Knowing myself I'll chicken out at the last minute, maybe too expensive for my account at this time.
Generally the Put/Call ratio is used to determine which way traders are leaning. For SPY there are roughly 2 puts for every call out there right now.
You are 100% correct in that with a call or a put your time and strike have to be spot on. The rewards are very high, but the probabilities are very small and the position works against you as time goes on. Below the white line is the current price behavior for the option and red is price at expiration. The white line moves closer to the red line each day until they are equal on option expiry day. The red ticks are the breakeven prices. For an April 152 put the breakeven drops from 152 to 149 just over 8 weeks. Again the rewards here are very high, but the probabilities are skewed very much against you.
Here is the profit/loss graph for a time spread (aka a calendar spread). Here you are still buying the same April 152 put, but you are also selling an equal number of next week's 152 puts. I did all the P/L graphs for 10 contracts, so you would be long 10 of the April 152 puts and simultaneously short 10 of the February 152 puts expiring next week. Here is the P/L graph for that trade. Again the white line will move to meet the red line until they are the same line on expiration day (next friday). Notice how in this trade the white line rises each day. Your max profit on this trade is $540, which is obtained if SPY closes at exactly $152 next Friday. Trade cost is $2470 (not including commissions) for the 10 contract spread. 20% isn't bad for a week's work. Breakeven points are 151 and 153 next friday so you have some wiggle room. You can tweak the strikes or the ratio to "lead" the underlying a little if you like, but that's getting a little more advanced.
Holding just 10 of the April $152 puts (the trade above) would cost you $3140 and if SPY finishes at exactly $152 next Friday you would be looking at a loss of $91. See why buying just plain vanilla calls or puts doesn't make much sense?
Now Mark, you're a pretty smart guy so I know you're going to bring up the fact that the chances of SPY closing at $152 on the nose next Friday are slim to none. Right you are. A much more likely scenario is you shutting the trade down next Wednesday or Thursday and rolling your short options forward another week so you can do it all over again. Here is how the trade would look next Wednesday (red line is price on Wednesday):
With SPY at $152 you are looking at $173 profit with breakevens at $153.10 and $150.84. That's no $540, but it's still a 7% return which IMO isn't half bad for a week long trade (2 days of which are the weekend and you worry about nothing) and the chances of SPY being between $151 and $153 next wednesday are much higher than the chances of you picking a closing price for SPY next Friday in order to make a vanilla put trade work.
Last but not least, keep in mind I just threw together this trade really quickly since you were looking at SPY to demonstrate a point. It's not really the most ideal trade for SPY considering we've been in an uptrend so if anything you would want to lead the trade forward some (if you think it's going to go up) or down some (if you think we're due for a pullback). You still have to read the charts, but at least this way you are stacking the odds in your favor.