Conversations on agile technical practices and investments

options cashflow strategies - wip

May 22, 2022

Key Points/Goals

  • options are about the trading - the buying and selling of risk
  • the objective is to generate high yield income from writing/selling puts and do so while minimizing risk as much as possible.
  • learning to identify the important factors in a trade and then lining up those factors as much as possible on your side, leads to clarity - you suddenly “get” why some traders are really successful and why others struggle.

psychology

  • adopt probabilistic mindset
  • keep diary of your trades
    • it’s essential on learning from your past mistakes
  • setup rules before entering
    • setup strategy on how to exit the position

Fundamental Analysis

Technical Analysis

patterns

  • uptrend
  • double bottom
  • inv. head and shoulders
  • cup and handle
  • kiss hello
  • ascending triangle
  • downtrend
  • double top
  • head and shoulders
  • inv. cup and handle
  • kiss goodbye
  • descending triangle
  • sideways trend
  • penant
  • rising wedge
  • falling wedge
  • bear channel
  • bull channel

Cash Flow

  • 5 minutes rule

    • it’s best to limit yourself to 1 or 2 positions, that is, options that have not yet been sold or used - at a time. Otherwise, it’s easy to lose track of how many open positions are in play.
    • checking the expiration date and the strike price. All of this information is located in the options chain. Many traders get into trouble here: if you enter 100 call contracts when you only meant ten or one, you have a problem.
    • check the bid-ask price, which is the highest price a buyer will pay and the lowest price a seller will accept. If the bid ask spread is too wide - meaning there’s too large a gap between the two - find another stock to trade. It’s too difficult to make a profitable trade if the bid and ask prices are too distant.
    • make sure you place a limit order and not a market order. It’s very risky to buy stocks at market price. Instead, a limit order lets you name your price, which should be somewhere between the bid and ask prices.
    • review the stock charts one last time to confirm that your initial observations still hold true.
    • you can always take 5 minutes - especially when it will keep you from rushing into a problematic trade because of a careless mistake.

  • covered call

    • for each 100 shares that a trader owns of an optionable stock, the trader can write (or sell) one call option (sell to open) against those shares in exchange for a cash premium payment.
    • if the stock closes at expiration above the strike price, the call will be exercised and the trader will be required to sell his or her underlying shares to the holder of the call at the agreed upon strike price.
    • if the stock closes at expiration AT or BELOW the strike price, the call will expire worthless, the trader retains the shares, and is free to write a new covered call if and when he or she chooses to do so.
    • the covered call writer may also buy back the call at any time prior to expiration (buy to close) for either a profit or a loss
    • rolling covered calls: buy back expiring calls and sell new call with later expiration
      • rolling out: rolling to later expiration and the SAME strike price
      • rolling out and up: rolling to later expiration and to a higher strike price.
      • benefits: not losing money on the roll, increases the strike price, and captures more of the cap gains.
      • drawbacks: requires longer rolls and smaller credits. Would not works when there’s big pops in stock.

  • naked puts

    • buy $40 put on a $45 stock, no matter how low the stock trades, you will be able to sell @ $40
    • a put writer becomes the insurance company. He or she collects the premium in exchange for assuming the responsibility of purchasing the shares should the shares be below the strike price when the put expires.

  • cash secured puts

    • strategy: writing short-dated, at the money, cash-secured puts on high quality companies when they’re trading at fundamentally and technically attractive prices.
      • fairly close to expiration date (20-45 days)
      • time value component of option is highest at the money.
      • fully backed with cash.
      • the biggest risk is when there’s big move lower
        • could be minimized in the trade setup
      • what does it mean to be high-quality?
        • might need to wait for the stock to be fundamentally sound or technically attractive.

  • bull spread credit spread

  • ratio call spread

  • What determine the price of an option

    • intrinsic value: difference between the underlying price and strike price
    • time value
      • volatility (expected/implied)
        • general market conditions or mood
        • company-specific history & events: earnings, legal/regulatory/other
      • time until expiration
      • dividends and dividend cycle
      • interest rates

Risk Management

  • option greeks:
    • delta: sensitivity to price change in the underlying security.
      • impacted by:
        • the strike price and share price
        • time remaining until expiration
    • the deeper in the money, the higher the delta. Inverse, the father out of the money, the lower delta.
    • as back door predicting mechanism
      • not very accurate (esp. longer dated)
      • delta 0.5 = 50-50 chance
      • delta 0.9 = strong likelihood to be in the money (ITM)
    • the farther away expiration is, the deeper in the money you need to generate high delta. A lot can happen to share price in long time period
    • gamma: sensitivity of delta to price change in the underlying security
    • theta: sensitivity to time. The amount of daily time decay in the price of option assuming nothing else changes.
    • vega: sensitivity to volatility changes. The amount of change to the option for each percentage unit change in the underlying security’s volatility
    • rho: sensitivity to interest rates. The amount of change to the option for each percentage unit change in interest rates.

the notion of r

  • the risk you predefine before entering a trade

exit strategies

  • percentage exits: step out at a 7-8% loss.
  • time exits
  • volatility exits

position sizing

Questions

Quotes

string of losses + poor money management = destroyed account

References

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Written by Tony Vo father, husband, son and software developer Twitter