Sell deep in the money option

[darrenmo]

What the "gurus" are talking about when they talk about insurance is buying puts, rather than selling them. So a portfolio you're describing (it's sometimes referred to as a "collar") will look smth like this:
Long stock (say, currently at 100)
Short the 150 strike call
Long the 20 strike put

The payoff on a structure like the one above looks, unsurprisingly, like a payoff of a call spread. Specifically, your downside is limited, but at the expense of accepting a limited upside. Furthermore, I find that describing the whole "covered call"/"buy-write" strategy as a way to "rent" shares is a little misleading. Unless, of course, you enjoy not getting the stuff you have rented back. Still, everything has its place.

Thank you for that, it's clarified a lot for me. Can I be so bold as to ask you for some general advice for how best to generate a monthly premium whilst keeping risk in check?

For example, do people ever sell a Call and a Put? What would you do if your only concern was to make 4% yield on the premium each month?

Thanking you in advance ...

 

[Martinghoul]

Thank you for that, it's clarified a lot for me. Can I be so bold as to ask you for some general advice for how best to generate a monthly premium whilst keeping risk in check?

For example, do people ever sell a Call and a Put? What would you do if your only concern was to make 4% yield on the premium each month?

Thanking you in advance ...

Yes, people do all sorts of things with options, including what you describe... However, you have to realise that there is no free lunch, especially from mechanically selling options.

Let me ask you this. What makes you think there is a way to make 4% return monthly? Have you considered what 4% monthly means?

Generally, there is no good way to answer your question. However, I can pretty much promise you that there is no simple systematic way to make a lot of money without accepting the risk of a very serious drawdown. To get a sense of how much money you can make, take a look at the professional option funds out there. The sorts of returns they demonstrate over a moderately long sample offer an estimate of the best you can hope to do (their transaction costs are a lot lower, etc). Check it out here: LJM*Partners – Performance History
The "aggressive" strategy is what you get when you sell options for premium.

 

[scose-no-doubt]

S'nothing. Trade2Winners make 20%+ per month in their sleep.

 

[Petrescu]

I buy OTM calls (home builder 2years) and sell near-OTM puts on high volatility stocks I want to own. All I can say is that for 2 months whoever sold me the OTM homebuilder calls made a good 5% monthly for 2 months but in the third month they lost 300%. So the takeaway is that by taking a 4% premium monthly is possible, but only by accepting a HUGE 300%-like risk that will eventually happen...by definition. Long Term Capital Management made just about 4% monthly for a few years selling premium. Than one day they lost 4,000% and went bankrupt.

 

[Petrescu]

In other words....that premium that you accept ever month and every year is really a ticking time bomb with a pink ribbon. If you hold it hong enough, eventually it will explode.

 

[Petrescu]

One more thing....if there was really a way to make a sure 4% monthly, I would retire tonight and put a downpayment on an island, or no a small country. That kind of profit is unthinkable without an enormous risk. 4% monthly is equivalent to a billion dollar lottery ticket. Do the math. It means you could buy the entire New York island in a few decades. People really underestimate the power of compounding, it's amazing really.

 

[Timetraveller]

Think about it this way bud...

When you're selling an ITM option, that extra $1 you make (or you think you're making) is unrealized. Meaning you havent MADE that profit yet. If you were to sell it, what profit will you make? Assuming zero slippage, it's $0.

Remember, just because you can trade it doesn't mean you should. Stick to paper trading for now.

 

[lloydbee]

People really underestimate the power of compounding, it's amazing really.

chick ching, good to see someone using their head...

Running a compounding 20% per month over a year or few which is very achievable, sure there is substantial $ risk but don't forget to fracture in probability which is often over looked...

If only human greed or our psychological make up didn't get in the way

 

[screw_jack]

In other words....that premium that you accept ever month and every year is really a ticking time bomb with a pink ribbon. If you hold it hong enough, eventually it will explode.

Options are insurance policies. When you sell them, you are hoping the premiums you are collecting will be enough to outstrip the loss you will inevitably incur when a disaster strikes.
On the other hand, no serious option trader would sell options blindly without any sort of hedge. There are conservative and consistent strategies that profit from collecting premiums.

 

[Scouser76]

Darrenmo asked a good question earlier though.

“However, if you thought the stock would drop wouldn't it be wiser to short the stock to make money on it?”

The point is that when you are selling (writing), and in fact buying an option, you are taking a view on the price of the OPTION rather than just that of the underlying (stock). You may feel that the option is overvalued, relative to your opinion of vol and the other parameters used for pricing them. This is the reason people might sell deep ITM options. They just think they’re too expensive and can get a quick buck by selling them. They could (should) also be part of a hedge or trading strategy. It could also be you think the stock isn’t going to change much at all. In which case, shorting it wouldn’t really help, but selling the option and letting theta eat away at the value could work.

 

[1414anon]

I hope this will clear your confusion about deep ITM calls..

-deep ITM calls//is as close as you can get to "arbitrage".(no risk at all.)..
very little gains ..very little risk to loose..

-sell a very deep ITM call (say delta o.9 or downside protection of 10-20 %
-if your stock gets called away..you make the extrinsic value of your originalcall (choose a call with some extrinsic value).
-if it stays flat or a bit lower (at expiry)...your cost of the stok is now reduced by -10-20%
and you can rewrite another deep ITM call.(or sell the stockand end up with a profit... cost of stock minus ITM call
-if it drops more than 10-20%..than you stand to loose(usually very little.and highly improbable)..again you can rewrite another deep ITM ..and so on

it is for people,who are satisfied with a 8-10% annual return..
to recapitulate... small gains.... huge protection against loss.(cash intensive)

i hope this helped.

 

[Martinghoul]

This is priceless... Selling DITM calls is arbitrage and very little risk!!! Who woulda thunk it!?

 

[1414anon]

I said selling DITM is" AS CLOSE YOU CAN GET ARBITRAGE...."...i didn't say it is arbitrage !!!!!..!!!!!!!~!!

there is a diff !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

 

[scose-no-doubt]

Hi 1414,

Can you please expand on how much exactly is "little risk you loose"?

Thanks

Scp

 

[Martinghoul]

I said selling DITM is" AS CLOSE YOU CAN GET ARBITRAGE...."...i didn't say it is arbitrage !!!!!..!!!!!!!~!!

there is a diff !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

Right, but what does this actually mean?

Selling DITM calls is pretty much as close to arbitrage as being short the underlying. And, btw, you're clearly very confused in your post. I am not sure you're ready to clear up anyone else's confusion quite yet.

 

[1414anon]

Can you please expand on how much exactly is "little risk you loose"?

Thanks


YOU define the strike price,by choosing your downside risk it can be 10,15 20%of the price you paid ,any drop greater than that is your risk.....(i.e. sell a call with a strike price of say 20% lower,than the price you paid for the stock..you start loosing when stock drops below 20%..of the price you paid.make sure your the call has an extrinsic value..that will be your profit if stock gets called away..it is a good idea to sell DITM call with a delta of 0.9 or greater...make sure you have an extrinsic value on the call..the price of the call will mimick inversly to price of the stock(almost equal..but not quite
you start loosing if stock drops more than 20%from your purchase price...you can also choose 10% downside protection for more profits(the call you sell will bring in more money)...but then again...your stock should not go down more than 10%..i.e.your risk gets bigger.chances of stock going down 10% is obviously greater than say 20%..

borntosell is a fairly good site..you get 10 free days of trial.and cancel before you pay noothing..my fav though is poweropt.com(free trial..no credit card required)..it scans the market real time
to find your specifications..
I don't bother much with downside risk,instead I use a delta of 0.9 for the call
and say an annual return of 10%,it automatically finds best trades,you can also specify say...to choose from sp 5stars stocks..

if it is not clear,than I will post some examples..

 

[1414anon]

Right, but what does this actually mean?

Selling DITM calls is pretty much as close to arbitrage as being short the underlying. And, btw, you're clearly very confused in your post. I am not sure you're ready to clear up anyone else's confusion quite yet.

thaks for the insult..I have been trading professionally for 15 years...
The question was about DITM calls...we are talking about around 8 % gains ANNUAL. do you know the costs of borrowing the stock????..do you know some stocks can not be shorted ????
I will no longer respond to your posts.

 

[Martinghoul]

thaks for the insult..I have been trading professionally for 15 years...
The question was about DITM calls...we are talking about around 8 % gains ANNUAL. do you know the costs of borrowing the stock????..do you know some stocks can not be shorted ????
I will no longer respond to your posts.

Huh? What does this have to do with anything, mate?

You realize that when you sell a call, you're short the underlying? So when the underlying sells off, you're gonna make money... What you seem to be describing in both your posts is a "covered call" (aka "buy write") trade (i.e. long the underlying and short the DITM call). Someone who's been trading professionally for 15 years should be able to tell the difference between covered calls and naked DITM calls.

Moreover, the idea that covered calls are somehow "low risk" is rather silly as well.

At any rate, feel free to not respond to my posts, but, in the same vein, you should stop offering advice to people.

 

[MacroStyle]

Anon, if i sell a DITM call and the stock price rises what happens to my P&L and how is it free?

You can talk about a covered call strategy but you are still short gamma. You don't understand options and need to stop giving advice right away before you cost other people money along with yourself.

 

[mensatrader]

Huh? What does this have to do with anything, mate?

You realize that when you sell a call, you're short the underlying? So when the underlying sells off, you're gonna make money... What you seem to be describing in both your posts is a "covered call" (aka "buy write") trade (i.e. long the underlying and short the DITM call). Someone who's been trading professionally for 15 years should be able to tell the difference between covered calls and naked DITM calls.

Moreover, the idea that covered calls are somehow "low risk" is rather silly as well.

At any rate, feel free to not respond to my posts, but, in the same vein, you should stop offering advice to people.

Hi Martinghoul, how have you been? Long time no see~~

I posted a thread about protective put strategy. There is something I really don't understand:

strike is K, and current stock price is S. Amercian put option is always worth more than the corresponding European put option (under same strike and maturity), since American put option is sometimes worth its intrinsic value K-S, it must hold true that the corresponding European put is sometimes worth less than its intrinsic value K-S, so does it mean that when the European put is worth less than the intrinsic K-S, I implement the protective put by buying the European put with premium p (less than its intrinsic K-S), then the worst case would be I only make profit of (K-S)-p?

just take a simple example: current stock price $3, strike price for a European put is $5, it seems possible for the European put to have premium less than ($5-$3)=$2, say $1.8 premium (because an American put can be worth its intrinsic $2 and american put is worth more than the european put). so it is possible for the protective put strategy to always have positive profit, right? Minimum profit is $5-$3-$1.8=$0.2. I know this should be a mistake but I don't know where I am wrong??

many thanks, mate