GLD Diagonal

[tjlocke99 18]

No, this is the type of trade you can get into anytime -- just do the math on it.  (And after more research,I actually think I like the ratio to start, and if the price falls, convert to a straight diagonal).   Please note I ignore commissions in my calculations because everyone's are different, please include them in yours.

 

For instance, the price of GLD is currently 115-116, and the Sep 116 Put is trading at 6.05 (12 weeks to expiration).  Let's say we want to do an 80% ratio again (like we did on SPY).

 

So 5 contracts of GLD will cost $3,025.00.  A 5% per week profit is $151,25, so for 12 weeks, $1,815.00.  That's a total of $4,840.00.

 

So how much do we need per week on an 80% ratio?  Well that's just = $4,840 / 100 / 4 / 12 = $1.01 per week.  Is that possible?  EASILY at the current GLD prices.

 

To further protect our shorts (just in case the ratio does not fully), we're going to go further out, to two weeks on our shorts, to the July 15, 2013 expiration.  Well the 118 strike gives us a $2.02 extrinsic credit -- which is just perfect. 

 

So if were to open this trade today I would:

 

-  Buy to open 5 SPY Puts Sep 116 @ 6.05

- Sell to open 4 SPY July 12, 2013 118 @ $3.80

 

Then in one we week we roll to the July 19.

 

What adjustments need to be made during the week?  Well if on Monday - Wednesday there's a BIG spike up (probably over $4-$5, I would consider rolling the July 12's up, we just have to look at the extrinsic values.  If things go down -- we don't worry about it.  The 20% ratio, and extended theta, will help cover the paper loss on the short.

 

The risk to the trade is a prolonged runup in the price of SPY, as that will drop volatility, lose value on the puts, and make getting our weekly premium's harder.  We can always roll up and out though.

 

What logic is used in choosing that long strike price?

 

Thanks!

[tjlocke99 18]

Do not touch it, until GLD price is above your long PUT. Example: I have Sep 126 PUT Long. I am not doing anything, until GLD goes above 126. If GLD goes above 126, I will start rolling it up and out at that point.

 

So you start looking at it if it goes ITM?  How far out of the money does it have to go before you look at rolling that long?

 

Thanks!

[cwelsh 1,551]

So you are always rolling the short out 2 weeks but holding it for one week?  e.g.  today you short the 12 July but next week you roll that to the 19 July?

 

Thanks!

No, not always, but at first yes -- and if the shorts are above the value of the longs, yes.

 

We do it to protect against the delta skew between the long and shorts. 

 

But when our shorts are significantly under the value of the long put strikes, we'll go back to one week at a time, particularly as that will make it easier to catch a rebound in prices -- which is a necessity if you have been losing on the shots weekly

[Maxtodorov 19]

So you start looking at it if it goes ITM?  How far out of the money does it have to go before you look at rolling that long?

 

Thanks!

 

Remember these are PUTs not CALLs.  I start looking at my longs when they go OTM.  If my LONG is 126, but GLD goes to 128,  I would have to go short above 128.... that would create a big margin requirements... So if GLD goes up to say 128, I would probably roll up my long to 128 and go another 1-3 month out. (the pricing would be the guide). 

[Guest Hal]

As of 2pm, GLD is at 118.60. I'm currently short the July 5 122 Put and looking to roll. The July 12 120 is at $4.15 with $2.24 time value, and the 121 is at $4.35 with $1.80 time value. My assumption is that the 120 is still better, because of the extrinsic value. Would you agree?

Just trying to keep mentally on top of this. Thx.

[Guest Hal]

Actually, the 120 is at $370 with $2.30 extrinsic. My mistake. Not sure now if the 121 isn't better because of the premium. 

[Maxtodorov 19]

Actually, the 120 is at $370 with $2.30 extrinsic. My mistake. Not sure now if the 121 isn't better because of the premium. 

 

121 has more protection if GLD was to pop UP. remember you are long as well, so if the GLD pops up, you need to capture all the intrinsic you can. 

[Guest Hal]

Here's the thing, however: I'm not really expecting GLD to pop. This possibly invalidates the whole reason for being in the trade, but I'm not seeing how this trade makes money if GLD continues to decline. Thoughts?

[cwelsh 1,551]

Here's the thing, however: I'm not really expecting GLD to pop. This possibly invalidates the whole reason for being in the trade, but I'm not seeing how this trade makes money if GLD continues to decline. Thoughts?

 

It does not invalidate the reasoning at all -- it just gives you some flexibility in the short strikes each week.  For this trade to work, we just have to capture extrinsic value -- no intrinsic from the moving prices.

 

We're actually better off if prices end up down by September, that way there will be intrinsic value in the long puts and we can make even more -- provided that we keep on pace selling extrinsically each week. 

[cwelsh 1,551]

And here are my trades on the day:

 

Buy to close July 5 122 put @ 6.67

Sell to open July 12 118 put @ 4.19

Buy to close July 12 118 put @ 3.00

Sell to open July 12 121 put @ 4.70

 

Net on day: -0.78.  (so increases the amount of extrinsic I need per week).

[Mikael 31]

No, this is the type of trade you can get into anytime -- just do the math on it.  (And after more research,I actually think I like the ratio to start, and if the price falls, convert to a straight diagonal).   Please note I ignore commissions in my calculations because everyone's are different, please include them in yours.

 

For instance, the price of GLD is currently 115-116, and the Sep 116 Put is trading at 6.05 (12 weeks to expiration).  Let's say we want to do an 80% ratio again (like we did on SPY).

 

So 5 contracts of GLD will cost $3,025.00.  A 5% per week profit is $151,25, so for 12 weeks, $1,815.00.  That's a total of $4,840.00.

 

So how much do we need per week on an 80% ratio?  Well that's just = $4,840 / 100 / 4 / 12 = $1.01 per week.  Is that possible?  EASILY at the current GLD prices.

 

To further protect our shorts (just in case the ratio does not fully), we're going to go further out, to two weeks on our shorts, to the July 15, 2013 expiration.  Well the 118 strike gives us a $2.02 extrinsic credit -- which is just perfect. 

 

So if were to open this trade today I would:

 

-  Buy to open 5 SPY Puts Sep 116 @ 6.05

- Sell to open 4 SPY July 12, 2013 118 @ $3.80

 

Then in one we week we roll to the July 19.

 

What adjustments need to be made during the week?  Well if on Monday - Wednesday there's a BIG spike up (probably over $4-$5, I would consider rolling the July 12's up, we just have to look at the extrinsic values.  If things go down -- we don't worry about it.  The 20% ratio, and extended theta, will help cover the paper loss on the short.

 

The risk to the trade is a prolonged runup in the price of SPY, as that will drop volatility, lose value on the puts, and make getting our weekly premium's harder.  We can always roll up and out though.

 

You mean prolonged run up of GLD right? not SPY? So it's kinda of like the anchor trade, the long put is our hedge and we are paying the hedge back through selling short. the general thesis is we think GLD will not have a large rally in 12 weeks so can continuously sell short to pay back our "hedge"and earn a profit until our long put expiration. 

 

Since this works on GLD and SPY, Would this work on other underlyings like DIA? 

 

seems to me an important criteria is the underlying should have experienced recent increases in volatility because it will allow us to get more credits on the shorts. 

[Guest Hal]

Okay Chris, I hear what you're saying, but my mind is blurring a bit. It's obvious to me that the long put makes money if the price of the underlying drops, but if every week I keep buying back the short puts for less than I'm selling them, how does the overall structure make money? It seems I'm better off just holding the long put naked if GLD keeps dropping (not suggesting doing this, just saying...).

 

I'm sure you have explained all this in detail elsewhere, so if you could please direct me to the proper post or thread, I'll be happy to read and try to understand this a little further. Right now...it's really quite a blur. Thanks.

[Maxtodorov 19]

Okay Chris, I hear what you're saying, but my mind is blurring a bit. It's obvious to me that the long put makes money if the price of the underlying drops, but if every week I keep buying back the short puts for less than I'm selling them, how does the overall structure make money? It seems I'm better off just holding the long put naked if GLD keeps dropping (not suggesting doing this, just saying...).

 

I'm sure you have explained all this in detail elsewhere, so if you could please direct me to the proper post or thread, I'll be happy to read and try to understand this a little further. Right now...it's really quite a blur. Thanks.

 

Hal, 

 

Look at the table below. If I capture $1.04 extrinsic in the next 12 weeks, I have achieved 4% weekly profit. You ask, how do we make money when GLD is going down, when we pay out every week. Well, the answer is shown with the green arrow. 

 

If today was expiration, the difference in strikes between my long (126 PUT) and short (120PUT), is $6. So if gold closed below $120, I would still collect $6 profit per contract share ($600). [in this case it would be $2400. So our goal is for GLD to just stabilize at any price point below $126, then we simply collect the extrinsic.....

 

Edited June 28, 2013 by Maxtodorov

[cwelsh 1,551]

I might not have.  The key is always the extrinsic value -- which is the "extra" value you get for selling an option.

 

Let's work through a short example  using closing prices:

 

GLD is currently at $119.11.

 

The July 5 119.5 Put sells for $2.45.  That's $2.06 of extrinsic value.  What happens if the price drops below $119.5 by expiration next week?  No matter what we "make" that $2.06.  Let's say the price drops all the way to $110.

 

Well you'd think you'd lose $9.50 (119.5-110), however since we received $2.06 in extrinsic value, we "only" lost $7.44.

 

 

The July 26, 2013 120 Put cost $4.30.  There's 4 weeks left, so to pay for it we'd need $1.08 extrinsic value each week.  Well we got that (and more) the first week.  (Remember GLD is at 110 right now).

 

The next week we sell the 110 put and get the same $2.45 (actually we'd get more because volatility is higher, but let's keep the numbers simple).

 

Once again the price drops, let's say to $105 this time.  Well our short's "lost" $2.55 (on a $5.00 fall).

 

Repeat that for two more weeks (GLD dropping to $100 then to $95).  We "lost" $2.55 twice more.  So right now, our shorts are down a total of $15.09. ($7.44 + $255 +$2.55 +$2.55).  Ouch, that's down quite a bit.

 

BUT, remember GLD is at 95, and we bought the $120 put.  That means on expiration day, it's worth $25, and it cost us $4.30, so it has a "net" worth of $20.70.

 

That means we make $5.61 on the trade ($20.70 - $15.09).  Not bad for losing on a short position every single week.

 

How in the world does this happen -- well it happens because of extrinsic value -- we earn that each week.  Since theta (time decay of that extrinsic value) accelerates closer to expiration, you get higher extrinsic value on a per day basis in shorter term options. Another way of looking at that is long term insurance is cheaper than buying short term insurance repeatedly. 

 

"Wow, I make money every time then, this is easy."  Well not so fast -- markets don't always decline just like we want them too.

 

The problem comes when the markets rebound.  Staying with the same example, where we lost $7.44 the first week and GLD is down to 110.  So the next week we sell the 110 option again, to capture that $2.45 extrinsic value.  BUT, GLD spikes back up to 120.  Now we're in trouble.  Sure we keep the entire $2.45 -- but with us being back to 120, the value of our long option is now less than $4.30.  In fact, it would be worth $3.40. 

 

So know we're "behind."  We lost $7.44 the first week, gained $2.45 the second week, and have lost $0.90 on paper on our long puts.  This is the problem I refer to as being "whipsawed around your long strike." 

 

That's also why we almost always sell ITM puts, and why you must ALWAYS sell ITM puts after a price drop (or loss in your shorts). 

 

Because in the previous example, instead of selling the 110 put the second week for $2.45, remembering we actually only need $1.08 extrinsic value, what if we sold the 113.5 for $4.58 ( Our $1.08 extrinsic value).  Well if the market spikes back up to $120, we're not as bad off -- we keep the entire $4.58, instead of the $2.45.  We're still behind, just not as much.

 

The next question people ask is "well then, after a market drop, and I've lost $7.44, I better sell the 117.5 puts, so I can gain back all that value if the market goes up."  The only problem with that is the $117.5 puts would only have about $0.30 in extrinsic value.  So if the markets drop, you only "make" $.30, when you need $1.08.

 

This is why we:

 

1.  Make early week adjustments in the event of a sharp spike up in value on Monday - Wednesday.  We can then "capture" that move up, and still get the extrinsic value we need in case things go back down;

 

2.  Sell two weeks out instead of one -- if there is a decline, it hurts "less" in a two week period then in a one;

 

3.  Prefer, if possible, to do this as a ratio trade as long as the long and short prices stay near each other.

 

I hope that helps, if not, feel free to ask more questions.

[Mikael 31]

Chris/Max a couple of questions:

1. If we are looking to start with a ratio, how should we decide on the ratio? are we trying to be delta neutral? so we add up the deltas of the long put side, and see how many short contracts are required to make it 0?

2. I think GLD is on a rally looking at the technical charts, so buying the long put at 119 is not good idea right now? Shouldn't i buy a higher put right now to prevent me from having to roll it really soon?

3. As per your discussion above, are we always selling ITM puts with JUST ENOUGH extrinsic value to cover our extrinsic needed/week? I'm just thinking if the long put delta is really close to 1, we can take a bit more risk and sell OTM puts to capture more extrinsic/week?

Thanks guys.

Edited July 1, 2013 by Mikael

[Guest giorgio]

with GLD at 121.60 $ and a put 122 july2, must we roll ?

 need 0.76 / week and received 1.45 of extrinsic value

[Maxtodorov 19]

I just rolled up (but I was at 120).

 

[Guest giorgio]

buy close july2  put 122 @ 2.90

sell  july2 put 124 @ 3.90  (Extrinsic 1.37)

[Marau 4]

I just rolled up (but I was at 120).

 

gld7-1.jpg

Hi Max

 

Only for educational purposes, would you explain the point of rolling now? 120 Put still has 1.96 extrinsic value and we can capture some intrinsic either, if the trend remains...

 

Thks

[cwelsh 1,551]

I just rolled as well, and will explain after lunch once I get caught up on some end of quarter things:

 

Buy to close July 12 121 Put @ 2.35

Sell to open July 12 124 Put @ 3.95 ($1.40 extrinsic at time of roll)

[brownrc 3]

No, this is the type of trade you can get into anytime -- just do the math on it.  (And after more research,I actually think I like the ratio to start, and if the price falls, convert to a straight diagonal).   Please note I ignore commissions in my calculations because everyone's are different, please include them in yours.

 

For instance, the price of GLD is currently 115-116, and the Sep 116 Put is trading at 6.05 (12 weeks to expiration).  Let's say we want to do an 80% ratio again (like we did on SPY).

 

So 5 contracts of GLD will cost $3,025.00.  A 5% per week profit is $151,25, so for 12 weeks, $1,815.00.  That's a total of $4,840.00.

 

So how much do we need per week on an 80% ratio?  Well that's just = $4,840 / 100 / 4 / 12 = $1.01 per week.  Is that possible?  EASILY at the current GLD prices.

 

To further protect our shorts (just in case the ratio does not fully), we're going to go further out, to two weeks on our shorts, to the July 15, 2013 expiration.  Well the 118 strike gives us a $2.02 extrinsic credit -- which is just perfect. 

 

So if were to open this trade today I would:

 

-  Buy to open 5 SPY Puts Sep 116 @ 6.05

- Sell to open 4 SPY July 12, 2013 118 @ $3.80

 

Then in one we week we roll to the July 19.

 

What adjustments need to be made during the week?  Well if on Monday - Wednesday there's a BIG spike up (probably over $4-$5, I would consider rolling the July 12's up, we just have to look at the extrinsic values.  If things go down -- we don't worry about it.  The 20% ratio, and extended theta, will help cover the paper loss on the short.

 

The risk to the trade is a prolonged runup in the price of SPY, as that will drop volatility, lose value on the puts, and make getting our weekly premium's harder.  We can always roll up and out though.

Hi Chris,   Understandably, most of the discussion re this trade relates to the weekly rolls.    However, please periodically review status/rules re the long put.    Per your comment above, someone getting into the trade at that time might have gone with a long Sept 116 put.    Sensing a surge in price, I went with Sept 118.      At what point would someone "roll up and out"   as the short term options move above the long put?     Appreciate your assistance.     Rob 

[cwelsh 1,551]

Rolling up and out is some what discretionary.  Typically you keep track of what your weekly returns need to be, and can roll up and out when you can do that, without taking on too much time, without having to change your per week goal.

 

(The below is a pure example with made up numbers).

 

So if we bought the Sept 116 put for $10.00, and needed $0.70 per week selling short to meet our profit goal, and can roll to the October $122 put, without changing that $0.70 mark, we might.  We don't want to get too far out in time though, because (a) if we do, and THEN there's a huge move up, it might be impossible to roll further out, ( it locks us into the trade for a longer period, © it increases the cost of the trade (thus possibly mis-allocating it in your portfolio).

 

The GENERAL guidelines I follow tend to be: (a) once a 5% move has occurred start thinking about rolling, ( at 7.5%, probably roll, © at 10% must roll.  That's just a general guideline though.

[brownrc 3]

Rolling up and out is some what discretionary.  Typically you keep track of what your weekly returns need to be, and can roll up and out when you can do that, without taking on too much time, without having to change your per week goal.

 

(The below is a pure example with made up numbers).

 

So if we bought the Sept 116 put for $10.00, and needed $0.70 per week selling short to meet our profit goal, and can roll to the October $122 put, without changing that $0.70 mark, we might.  We don't want to get too far out in time though, because (a) if we do, and THEN there's a huge move up, it might be impossible to roll further out, ( it locks us into the trade for a longer period, © it increases the cost of the trade (thus possibly mis-allocating it in your portfolio).

 

The GENERAL guidelines I follow tend to be: (a) once a 5% move has occurred start thinking about rolling, ( at 7.5%, probably roll, © at 10% must roll.  That's just a general guideline though.

Thanks Chris.    Very clear.    There was another opinion voiced earlier in the forum that would have rolled sooner and possibly further out.   Appreciate the clarification.     

[cwelsh 1,551]

Thanks Chris.    Very clear.    There was another opinion voiced earlier in the forum that would have rolled sooner and possibly further out.   Appreciate the clarification.     

This is why I like writing on this site -- it encourages education and independent though.  I could make a great argument for rolling sooner and even further out -- namely it reduces forward risk and makes the amount needed per week less.  I personally am more worried about tail risk and possible increasing prices.  Ideally I want everyone to understand the thinking behind the strategy so they can come up with what they are most comfortable with instead of blindly following recommendations.

 

If you're more into having someone else make the decisions, as many are and there's nothing wrong with that due to time constraints or whatever -- well that's why I also run an investment advisory firm that handles client portfolios.

[tjlocke99 18]

Do not touch it, until GLD price is above your long PUT. Example: I have Sep 126 PUT Long. I am not doing anything, until GLD goes above 126. If GLD goes above 126, I will start rolling it up and out at that point.

 

Sorry - I see this was already answered.

Edited July 2, 2013 by tjlocke99

[Guest Hal]

Chris and Maxtodorov – I wanted to sit down with all this over the weekend and crunch numbers, but family obligations intervened. I got up early this morning, read through the thread, did some math (math before coffee – ugh) and think I have a good grasp on how the strategy works. Thanks to you both for your clear examples and explanations.

Two questions about stock selection: 

• I see us applying this strategy with GLD and SPY. What are some of the criteria in selecting a stock or index to apply this strategy to? I understand that we're betting that a stock won't pop above a certain range. Beyond that, what else are we looking for? Liquidity? How about BETA? – I can imagine you're more likely to get whipsawed with a high-BETA stock than a fairly stable stock – but then, the extrinsic values are likely to be higher as well. What's the "sweet spot"?
• What kind of timeframe do we want to pick for the long put? In the case of GLD, why did you choose the September expiration? If you were to open this as a new trade, and still believe GLD is in a general downward trajectory, would you still pick Sept, or would you go out to October?

I'm still not in the SPY diagonal, so I'm going to try looking at the charts, and picking my own timeframe. I'll post some thoughts to the SPY thread before initiating any trades.

 

Thanks again to you all. This really is like "learning to fish" – instead of being given a fish. Much more useful in the long run.

[cwelsh 1,551]

Chris and Maxtodorov – I wanted to sit down with all this over the weekend and crunch numbers, but family obligations intervened. I got up early this morning, read through the thread, did some math (math before coffee – ugh) and think I have a good grasp on how the strategy works. Thanks to you both for your clear examples and explanations.

Two questions about stock selection: 

• I see us applying this strategy with GLD and SPY. What are some of the criteria in selecting a stock or index to apply this strategy to? I understand that we're betting that a stock won't pop above a certain range. Beyond that, what else are we looking for? Liquidity? How about BETA? – I can imagine you're more likely to get whipsawed with a high-BETA stock than a fairly stable stock – but then, the extrinsic values are likely to be higher as well. What's the "sweet spot"?
• What kind of timeframe do we want to pick for the long put? In the case of GLD, why did you choose the September expiration? If you were to open this as a new trade, and still believe GLD is in a general downward trajectory, would you still pick Sept, or would you go out to October?

I'm still not in the SPY diagonal, so I'm going to try looking at the charts, and picking my own timeframe. I'll post some thoughts to the SPY thread before initiating any trades.

 

Thanks again to you all. This really is like "learning to fish" – instead of being given a fish. Much more useful in the long run.

 

One of the most important criteria to look at is liquidity of options, making sure there are weeklies, and pricing spreads.  There's surprisingly few stocks/etfs that fit those criteria.  Things with too low of volatility don't work (so like KO, JNJ, etc) because their options are too cheap on a  weekly basis -- you simply cannot get enough credit to offset risk and commissions (commissions can be in huge accounts), but you still have no hope of a good profit target.  

 

And once you get too volatile (AAPL for example), the problem is just as you noted -- whipsawing becomes more likely.

 

THOUGH, I have not modeled AAPL on the ratio/non-ratio trade like I'm doing on SPY now, where:

 

a.  Buy long dated Put;

b.  Sell your shorts at a ratio to offset the difference between the deltas on the long and short position;

c.  Once the position has gone down, and the deltas get closer, then eliminate the ratio and just trade at a diagonal (so as not to miss on a rebound).

 

That might very well work, but I have done zero back testing on it, and I won't commit a ton of capital to a trade I don't have at least some idea of whether it would historically work.  (We should have a thread for people willing to test ideas like that).  For all I know AAPL might work better in a ratio/diagonal combo trade.

 

 

Time frames are more up to you and how long you want your capital committed to a trade.  You don't want to go TOO far out, as rolling up and out, if needed, would be difficult.  Going further out also risks a dramatic drop in volatility, which changes your profit/loss structure.  If the options you are selling weekly all of a sudden get a lot cheaper (and your long also loses value to the drop), it can turn ugly.  In shorter terms, that's less likely (it still can happen of course, just harder too). 

[Mikael 31]

Hi Chris when we initiate this kind of trade do we always long the ATM put?

[cwelsh 1,551]

What logic is used in choosing that long strike price?

 

Thanks!

The current price of the equity.

 

So if GLD was at 120, we'd use 120.  If it were at 210, we'd use 210.

[cwelsh 1,551]

Hi Chris when we initiate this kind of trade do we always long the ATM put?

For this trade yes -- but there are dozens of variations that can use calls, reverse diagonals (where you short the long instead), and so forth.  But for this trade, built on this model, yes.

[Mikael 31]

Chris, i was just thinking about the risks on this type of trade. 

 

What happens if 1 day before expiration or even on the day of expiration of the short put, there is a drastic move against our short position (i.e GLD all of sudden experiences a large drop in price). It's my understanding that gamma is at it's most extreme when it's close to expiration. so in that case, our long position cannot cover the losses incurred (since we must buy to close our short position to avoid assignment) correct? 

[cwelsh 1,551]

I'm rolling today

 

Buy to close the July 12 124 @ 6.80

Sell to open the July 19 122 @ 5.50

 

Max extrinsic value: .80

[tjlocke99 18]

I'm rolling today

 

Buy to close the July 12 124 @ 6.80

Sell to open the July 19 122 @ 5.50

 

Max extrinsic value: .80

are you still long the sept 125?  Is that getting too DITM at this point where you can get whip-sawed?  Are you still doing ratios or are you at 1:1 on this?

 

Thanks!

[tjlocke99 18]

I'm rolling today

 

Buy to close the July 12 124 @ 6.80

Sell to open the July 19 122 @ 5.50

 

Max extrinsic value: .80

 

Also Chris,  the max extrinsic would be if you held the short for 2 weeks, however you've been shorting w/ expiry 2 weeks out and holding for 1 week, so you'll probably only realize 1/2 of that extrinsic right?

 

Thanks!

[Maxtodorov 19]

Also Chris,  the max extrinsic would be if you held the short for 2 weeks, however you've been shorting w/ expiry 2 weeks out and holding for 1 week, so you'll probably only realize 1/2 of that extrinsic right?

 

Thanks!

 

We get less than 1/2 due to Theta effect. [where theta is higher closer to expiration]. I am thinking that Chris, rolled the way he did, due to significant drop in price. At this point if we roll to low on the price, the potential rebound would cause us to loose on the intrinsic. By keeping it DITM, we are protecting ourselves from rebound risk. 

[cwelsh 1,551]

I'm 1:1 now.

[cwelsh 1,551]

We get less than 1/2 due to Theta effect. [where theta is higher closer to expiration]. I am thinking that Chris, rolled the way he did, due to significant drop in price. At this point if we roll to low on the price, the potential rebound would cause us to loose on the intrinsic. By keeping it DITM, we are protecting ourselves from rebound risk. 

Correct -- and by going two weeks out, in conjunction with the ratio trade, we experience less loss on the shorts in a down market -- while still collecting extrinsic value.  I'm now 1:1, so if the market does rebound, I don't get whipsawed, and as my deltas are slowly getting closer together between the longs and shorts, a continued downward move does not hurt as much,.

[Maxtodorov 19]

Chris, 

 

I think having our LONG being very DITM, it may be time to switch to 1 week expiration roll. I perceive the risk of loosing intrinsic on the way up as my primary concern. If I roll out now, with Delta on the current week short being so close to 1, and at the same time, in order to capture meaningful extrinsic, we have to drop our strikes. Sudden RUN up could leave money on the table... with 1 week expiration our delta would be closer to 1 and we will capture all the intrinsic. I do understand that same applies on the way down, but another couple of $$ down and our long will have a Delta close to 1 as well. 

Edited July 5, 2013 by Maxtodorov

[Maxtodorov 19]

Rolled as well. GLD did a strange pop in last hour. Right before my roll. 

[Guest giorgio]

buy close july12 put 124 @ 6.78

sell july19 put 121 @ 4.60   (Extrinsic value 0.92)

[tjlocke99 18]

Correct -- and by going two weeks out, in conjunction with the ratio trade, we experience less loss on the shorts in a down market -- while still collecting extrinsic value.  I'm now 1:1, so if the market does rebound, I don't get whipsawed, and as my deltas are slowly getting closer together between the longs and shorts, a continued downward move does not hurt as much,.

Max and Chris,

 

Why not roll the ITM long now?

 

These are certainly not easy trades to manage.  You almost need GLD to go up and eat some of the short intrinsic to help.

 

Would either of you mind posting your P&L so far?  I think you have probably lost a fair amount on paper right now right?

 

Thanks!

[Maxtodorov 19]

Max and Chris,

 

Why not roll the ITM long now?

 

These are certainly not easy trades to manage.  You almost need GLD to go up and eat some of the short intrinsic to help.

 

Would either of you mind posting your P&L so far?  I think you have probably lost a fair amount on paper right now right?

 

Thanks!

 

I would not TOUCH the LONG. The trade is doing excellent. Remember we sold ATM, now its DITM. So as of today.... with GLD being $118, my PUT is $8 in the money. I do not have P&L complete, as I have not sold the LONG... but here is my trade status.  But this sheet has three key points: 

1. The future sale price of LONG GLD is excluded. 

2. Profit, while is a NON cash expense is included as a cost. 

3. if i get $.89 (extrinsic) per week, i achieve 4% per week profit, even if the Long expires worthless. 

 

 

Edited July 5, 2013 by Maxtodorov

[Maxtodorov 19]

 

 

Why not roll the ITM long now?

 

 

 

DITM (GLD - 126 PUT Sep), has a Delta closer to 1 (.69). ATM would have a delta .5.  So any further drop, would give you a bigger paper loss, if you were to roll. Plus you would be paying more extrinsic for ATM. If market goes up, you would have to roll up. Bottom line, unless you are done with the trade, an ATM that became DITM should be left alone. 

Edited July 5, 2013 by Maxtodorov

[tjlocke99 18]

Thanks Max.  When you show 400 long and 4 short does that mean you were 1:1 one the whole time on this trade?

 

How is the trade doing well?  If you exclude the money taken in on Fri, the trade seems like it has lost quite a bit and thus requires gold to go up to make up some of the losses and when that happens the long's value will go down?  Right now the long is probably worth about $4k right?

 

I appreciate the info!

 

Thanks!

 

R

[Maxtodorov 19]

Thanks Max.  When you show 400 long and 4 short does that mean you were 1:1 one the whole time on this trade?

 

How is the trade doing well?  If you exclude the money taken in on Fri, the trade seems like it has lost quite a bit and thus requires gold to go up to make up some of the losses and when that happens the long's value will go down?  Right now the long is probably worth about $4k right?

 

 

Yes, I was 1 to 1 right away. In this trade we WANT GLD to stay below 126. Lets assume GLD will NEVER go up and stay at $118 till end of the trade. At expiration my LONG 126 will gain all the DELTA. So it will be 126-118 = 6 , times 400, would be $2400. In the mean time there are many weeks left, and we can continue get weekly premium. As long as I get $.89 per week extrinsic, I still would capture 4% profit.  At this point, the long is worth $4K or so. So if I liquidate today, I would be about broken even. 

 

If GLD goes up, I will immediately collect intrinsic, but long will loose..... which is OK, as loss (on LONG) will be slower as gain (on short). [due to Delta being higher on short]

 

If GLD goes further down, the shorts will loose, the long will gain... the further it drops, the DELTA would get closer to 1(on LONG), so losses will be smaller the further down it goes. However, every dollar lost on a down move today, is only a CURRENT CASH loss, every dollar lost today, will be gained back at expiration if the GLD does not rebound, or captured via intrinsic on the way UP. (In other words, our shorts would be very profitable if there is a rebound) 

 

There are 2 key risks to this trade: 1. GLD goes up TOO fast, for example if it suddenly goes to 124 overnight, my short will only gain $1571 at most, yet the LONG may loose more than that. 2.  Long term (next 2 month) GLD going above 126, as that will quickly eat away at our long. Above $126, we would have to roll up, or have margin coverage. 

[Mikael 31]

TJ, let me try to explain this to you from my understanding, if there are any errors in my explanation perhaps Max and Chris can clarify. If something isn't clear, you can ask me.

The thesis of the trade is this: You believe GLD is on an overall downward trend, you buy a long put and believes by expiration GLD price should settle below your long put strike price (this is the best case scenario), you collect extrinsic value by shorting GLD puts each week until the expiration of the long put to reach your profit target.

There two components to this trade.

LONG PUT: You buy an ATM put for x number of weeks into the future, you believe the price will settle somewhere at or below the strike of the long put you purchased by expiration. You set an profit traget (eg. 5% per week for X # of weeks) and calculate how much extrinsic value you need to acquire each week off your shorts to achieve that target.

SHORT PUTs: You sell the # of contracts each week to achieve that target you set (the strike you sell at should be the strike that gives you exactly the amount if extrinsic you need, why? because if you sell a strike with more extrinsic you need, the strike is usually further away to the underlying price, so more OTM, in case of a upwards rally on GLD, you will get to keep less intrinsic. Keeping more intrinsic help you offset losses due to the difference in deltas between your long and short position, i explain it further below), when you short the puts 1 of 3 scenarios can occur by the time you need to buy to close and sell to open for the following week:

scenario 1: GLD price does not move and is equal to your strike price by week's end: well that's great, you just collect the extrinsic value because theta is negative and vega is positive. since GLD price didn't move, theta has decayed away most of the value and you don't pay more to close because vega probably didn't really move much since the GLD price didn't decrease.

scenario 2: GLD price settled above your strike price by week's end: well that's even better, you collect the extrinsic and even a bit more because now when you buy to close, your GLD strike is further OTM, making it even cheaper.

scenario 3: GLD price settled below your strike price by week's end: well that sucks, you see a paper loss. it cost more to buy to close because now your short put has intrinsic value in it because it's ITM. but wait maybe you didn't lose money at all? how? well your long put is now further ITM, all the paper loss you see on your short put maybe covered by the gains on your long put! However this is not always the case. Why?

a. The deltas on your long and short puts are not the same. Usually gamma on options closer to expiration are much greater than longer dated options. So in the scenario where the price of GLD all of a sudden drops $2 dollars in one day, or even worse, drops 2 dollars on the day you are suppose to close (usually a friday), your short delta is going to be 1. whereas your long put delta maybe less than 1. so in that case, the gains on your longs will not sufficiently cover your paper loss on the short.

b. if the price drops on your short, because you have to buy to close, vega maybe pretty high, so you are paying more to close your position. if vega increased alot, it may even offset the negative theta you have been collecting. which means you got hit by a double negative. you gains on your short from time decay got offset by the increasing vega. and your delta on your long is less than the delta on your short, so your intrinsic loss wasn't covered by your long put either.

and the above two reasons is why you never roll your long put if it's DITM, because the delta will be close to 1. if both deltas are 1, you have eliminated all your gamma risk, and you can be sure that any paper loss on your short positions will be covered by your DITM long put. All you have to do is sell at your extrinsic every week and make your profit target.

this is also why Chris suggested to do a ratio in the beginning. Because when your long put is not yet DITM, you have that difference in delta between your long and short. If you short in a smaller ratio than your long, and if the price drops substantially as in what i described in a. and b. then that ratio will partially offset your delta difference. when your long is sufficiently DITM where both deltas are 1,then you can forget the ratio and do 1:1 long:short.

Since you have 2 ways to win on your short vs. 1 way to lose, and if your long put is DITM, you pretty much have no way to lose.

In summary, I believe It is an excellent trade if you believe GLD will not have a big rally anytime soon.

If you look at the overall economic conditions

- Fed is beginning to taper their bond buyback

- This will drive up long term interest rates

- This will give bonds and other debt instruments more yield

- this will lead to a decrease in gold prices because it makes gold, which yields nothing, an less attractive investment option.

- so I don't believe there will be a BIG rally in gold prices soon.

In general based on overall economic conditions and the thesis of this trade, I believe it will be profitable if executed correctly.

Edited July 6, 2013 by Mikael

[tjlocke99 18]

Thanks Mikael!

[tjlocke99 18]

Yes, I was 1 to 1 right away. In this trade we WANT GLD to stay below 126. Lets assume GLD will NEVER go up and stay at $118 till end of the trade. At expiration my LONG 126 will gain all the DELTA. So it will be 126-118 = 6 , times 400, would be $2400. In the mean time there are many weeks left, and we can continue get weekly premium. As long as I get $.89 per week extrinsic, I still would capture 4% profit.  At this point, the long is worth $4K or so. So if I liquidate today, I would be about broken even. 

 

If GLD goes up, I will immediately collect intrinsic, but long will loose..... which is OK, as loss (on LONG) will be slower as gain (on short). [due to Delta being higher on short]

 

If GLD goes further down, the shorts will loose, the long will gain... the further it drops, the DELTA would get closer to 1(on LONG), so losses will be smaller the further down it goes. However, every dollar lost on a down move today, is only a CURRENT CASH loss, every dollar lost today, will be gained back at expiration if the GLD does not rebound, or captured via intrinsic on the way UP. (In other words, our shorts would be very profitable if there is a rebound) 

 

There are 2 key risks to this trade: 1. GLD goes up TOO fast, for example if it suddenly goes to 124 overnight, my short will only gain $1571 at most, yet the LONG may loose more than that. 2.  Long term (next 2 month) GLD going above 126, as that will quickly eat away at our long. Above $126, we would have to roll up, or have margin coverage. 

Max,

 

How will you account in your spreadsheet if you have to re-position the long at all?

 

I don't understand how the trade is going well.  If I entered the same position last Friday at end of day, wouldn't I be as well or better off as those in the original trade?  I would be out about $4k out of pocket for the DITM long and take in around $1571 for the short.  My long would be worth $4k and my short -$1571, so I would be about break even at that point and have the same allocation as you.  You are about break even now.

 

I think this trade is really going to make money when the underlying is flat or when it goes up a few points over the course of a week, so you can capture all that intrinsic gain on the short puts.  Any other movements and we are re-structuring to keep our heads above the water.

 

Does that make sense?

 

Thanks for all these good responses!

[tjlocke99 18]

As I look at this trade, and what we know about equivalent option positions, I don't get how this is different then buying a long dated OTM put and selling a lower ratio of shorter dated OTM puts and then adjusting from there week to week or vice versa with calls?

 

Yes w/ the current strategy your shorts gain quite a bit early in the trade if the underlying price goes up, however your long puts also lose a near equivalent amount if you are in a ratio.

[cwelsh 1,551]

are you still long the sept 125?  Is that getting too DITM at this point where you can get whip-sawed?  Are you still doing ratios or are you at 1:1 on this?

 

Thanks!

 

You can never go too DITM -- the further DITM you go, the better, as that means any losses on the short side will be completely offset by gains on the long -- leaving you to capture only extrinsic value.  The only real risk is a quick and sharp move to the upside, so you lose intrinsically -- but on weekly positions, that's much easier to manage by rolling the shorts up during the week.

 

I am now 1:1 on the GLD as it is further ITM