A question about POP and Maximum Loss

[CXMelga 0]

 

Can you please help me with the following question regarding probability of profit and max-loss

If you look at the following trade from an option witters perspective a call credit spread in Apple Inc. Jan 2019 expiry

POP 82%

EXT 55.00

P50 91%

Max Profit 55.00

Max Loss -445.00

POP (probability of profit) and Max Profit verses the Max-Loss, it looks like the above is a bad deal from an option seller’s perspective (as far as I understand options at this time) as

If I sell the exact same option 100 times

82 times out of one hundred I stand to make $55 (82 x 55 = 4,510)
18 times out of one hundred I stand to lose $445 (18 x 445 = 8,010)

Therefore, all else being equal I stand to loose twice as much as I gain on this deal (as premium too low for the writer)

If I look at the POP at 50% = 91%

Therefore 50% of the max profit is 55 / 2 = $27.50

My question is as follows

If I consider the trade at POP 50% (e.g. setup an automatic GTC at 50% profit), ‘can I also consider’ the max-loss is also reduced by 50% from 445 to 222.5?

I guess not as the max-loss could occur at any time e.g. the next day the stoke smashes through the strike prices and I am assigned.

However, if I could consider my max-loss are also half (if I always sell at 50% of max profit) then

91 times out of one hundred I stand to make 27.50 (91 x 27.50 = 2502.50)
9 times out of one hundred I stand to lose 222.50 (9 x 222.50 = 2002.50)

Looking at the above, it now turns from a bad deal for the option writer to a good deal for the option writer, (providing my max loss reduced to  50% along side of 50%POP )

I would appreciate if someone could get back to my on my thoughts above please

 

 

[cuegis 683]

2 hours ago, CXMelga said:

I guess not as the max-loss could occur at any time e.g. the next day the stoke smashes through the strike prices and I am assigned.

Well, you could avoid that from happening by trading many of the futures options.

They have enormous liquidity and many of them (ex. Crude Oil among others) are open 23 hours a day, including the options.

In crude, everything is .01 cent bid/ask....even 4 leg spreads for the most part.

So there is no risk of overnight gaps, and liquidity 23 hours a day.

No real assignment risk either as most futures options have a lot of premium in them and nobody is giving that away.

Also, the margin rules are much more favorable.

 

Just something to look into.

[CXMelga 0]

Hello Cuegis,

Thanks very much for taking the time to reply to my question,

Yes, commodities is something I have been thinking about as it occurs to me they 'may' be more predictable especially hard commodities like oil, metals etc. as opposed to soft (farmed) due to unexpected bad weather draught/flood 

So basically I am thinking (and still learning the whole area) where as stokes can be affected by the CEO saying the wrong thing or a thousand other possibilities, commodities are more based on supply/demand over the longer time frame (year plus) so a bit more predictable 

I understand features are contracts which 'obligate' the seller to sell X to the buyer at Y price on Z date, but the buyer can sell the contract before Z date

Now with options the buyer has the 'right' but not the 'obligation' and can also exercise (whether ITM or not) the option, or sell the option (I believe that is also true) before expiry

My question is then (if the above is correct),

can I buy/sell 'options' on 'features'  which I believe are both considered derivatives, if so is that in essence a derivative on a derivative ?

Thanks very much for you time, helping me understand all this, as if I can sell (or buy for hedging) traditional options contracts on feature contracts that is something I would be very interested in 

Thanks 

CXMelga   

[zxcv64 710]

16 hours ago, CXMelga said:

can I buy/sell 'options' on 'features'  which I believe are both considered derivatives, if so is that in essence a derivative on a derivative ?

I'm not Ceugis, but allow me to jump in.

Firstly I think you mean 'futures' and not 'features'.

Secondly, yes you can trade options on futures. However, the volumes can be small for some commodities and expiries. 

Thirdly, pls forget all notion that commodities are easier to predict - even hard commodities like oil. Just have a look at what oil has done for the last 12 days - it's broken a record and fallen consecutively for all of them. Here's a chart. 

 

Fourthly, remember that it's not only the agricultural commodities which are affected by the weather. Want an example? Have a look at what the cold weather has done to natural gas  :

 

 

Commodities and futures trading is a whole different ball game. 

 

z

[FrankTheTank 839]

I am clearly not an expert in this but I highly suggest listening to the option alpha podcast as he does several episodes covering this question.  If I remember correctly, the POP is calculated at the time of entry and it can change overtime.  According to the millions of backtests they ran, the profit is almost always greater when closed than the original POP.   

 

I don't know if that is enough to justify the specific AAPL trade you cited but its interesting to keep in mind that you have some 'wiggle room' usually to the upside when you see an initial estimate of POP.

 

Edit:  I should clarify this is only true for option sellers.  I think its because IV is usually overstated initially at the time you open your position.  

 

 

Edited November 14, 2018 by FrankTheTank

[CXMelga 0]

Thanks very much Zxcv64 and FrankTheTank

I really appreciate you both taking the time to help me understand/learn

Thanks for the explanation and charts Zxcv64 t:)

So basically, if I want to trade options on Futures/commodities I just need to look for the correct 'ticker symbol' (where the underlying is a commodity rather than a stock) then buy/sell a contact based on the ticker ?

I placed my very first options contract on Wednesday did a put credit spread (Vertical) on SPY with a POP of 78% (all going in my favour at the moment)

 

[cuegis 683]

52 minutes ago, CXMelga said:

Thanks very much Zxcv64 and FrankTheTank

I really appreciate you both taking the time to help me understand/learn

Thanks for the explanation and charts Zxcv64 t:)

So basically, if I want to trade options on Futures/commodities I just need to look for the correct 'ticker symbol' (where the underlying is a commodity rather than a stock) then buy/sell a contact based on the ticker ?

I placed my very first options contract on Wednesday did a put credit spread (Vertical) on SPY with a POP of 78% (all going in my favour at the moment)

 

SPY is not categorized as a "commodity" and is under the rules of the SEC and Reg-T margin rules.

Commodities futures contracts, and futures options are under the authority of the CFTC and FTC rules, and margined based on the SPAN margin system.

SPY, and it's options,  is considered a stock just like any other stock, and is margined the same way, and traded during the same trading hours.

 

An example of an identical commodity , which is open 23 hours a day (options too), and margined under the SPAN system, would be ES.

It is $50 per point, and margined as a commodity.

It moves identical to SPY and SPX.

It is only closed between 5PM- 6PM EST

Edited November 16, 2018 by cuegis

[cuegis 683]

52 minutes ago, CXMelga said:

Thanks very much Zxcv64 and FrankTheTank

I really appreciate you both taking the time to help me understand/learn

Thanks for the explanation and charts Zxcv64 t:)

So basically, if I want to trade options on Futures/commodities I just need to look for the correct 'ticker symbol' (where the underlying is a commodity rather than a stock) then buy/sell a contact based on the ticker ?

I placed my very first options contract on Wednesday did a put credit spread (Vertical) on SPY with a POP of 78% (all going in my favour at the moment)

 

Sorry...in my last post, just before this one, I misread your post and thought you had said that you just traded your first "commodity" option....

My mistake!