Newbie Options Trading

[pz1975]

One might also consider offering a bid just below a bid price initially.

I always (and I hope everyone here does too) initially try to buy/sell options between the bid-ask prices and slowly modify my bid/ask up or downwards. Often you can get the cost for halfway in between the bid-ask if the liquidity is high.

When the bid-ask spread is larger, however, like the Jan17 LEAPS will be at first, you are more likely going to pay closer to the full bid price since the liquidity will be very low at first for these new options.

 

[pz1975]

For very long term options you should always be able to buy for less than the ask and sell for more than the bid. Unless you expect the stock to move very quickly it is usually worth spending a little time setting your bid or ask as high or low as you can and then slowly moving it up/down. At least that is normally my strategy with LEAPS

As for transaction fee it varies a lot but at my broker it really is not enough to matter when talking about LEAPS that are worth thousands.

Agree but you will still usually "lose" a bit when selling one option and buying another. It would be unlikely to be able to sell the 260 for halfway between the bid-ask prices and then get the 280 for halfway again. You are much more likely to sell the 260 closer to the bid price (lower) and then have to buy the 280 closer to the ask price (higher). The cost of doing that + the smaller factor of the transaction fees will eat into the potential profit gain if the stock goes up and worsens the loss if the stock stays the same or goes down.

 

[InTheShadows]

I never pay ask unless I am playing weeklies and for some reason I really want that contract. Usually this has been a dumb move on my part.

No for what I normally do. When buying I usually enter a price slightly below the mid point. When selling, slightly above. This usually ends up with the contract executing at the price I am after on a high volume stock like tsla. The open interest has a lot to do with it.

 

[AlMc]

I always (and I hope everyone here does too) initially try to buy/sell options between the bid-ask prices and slowly modify my bid/ask up or downwards. Often you can get the cost for halfway in between the bid-ask if the liquidity is high.

When the bid-ask spread is larger, however, like the Jan17 LEAPS will be at first, you are more likely going to pay closer to the full bid price since the liquidity will be very low at first for these new options.

Absolutely agree. The new LEAPS will almost certainly have a large bid/ask spread initially and that spread will come down over time. What would help accelerate that would be some sideways trading on the TSLA price for awhile. I have no idea if that is going to happen.





http://finance.yahoo.com/news/japan-says-economy-contracted-1-6-pct-july-000851820--finance.html Not good for short term

 

[chickensevil]

Agree but you will still usually "lose" a bit when selling one option and buying another. It would be unlikely to be able to sell the 260 for halfway between the bid-ask prices and then get the 280 for halfway again. You are much more likely to sell the 260 closer to the bid price (lower) and then have to buy the 280 closer to the ask price (higher). The cost of doing that + the smaller factor of the transaction fees will eat into the potential profit gain if the stock goes up and worsens the loss if the stock stays the same or goes down.

First depending on the underlying stock price and time remaining and the strike you are looking at, rolling forward might actually be more profitable on a per dollar movement because eventually time value starts to really get priced out if it goes deeper ITM.

Second, unless you REALLY want to buy the underlying shares, at some point you have to do some kind of sell and roll. When you choose to do this is up to you... But it has to happen at some point before expiration... One year, one month, one week, one day, one hour... It would still be a roll.

This isn't like stock where you just hold until you feel like selling... There is a whole dynamic to timing... And there is a lot that goes into making that right timing call, but at some point you have to sell.

 

[pz1975]

First depending on the underlying stock price and time remaining and the strike you are looking at, rolling forward might actually be more profitable on a per dollar movement because eventually time value starts to really get priced out if it goes deeper ITM.

Second, unless you REALLY want to buy the underlying shares, at some point you have to do some kind of sell and roll. When you choose to do this is up to you... But it has to happen at some point before expiration... One year, one month, one week, one day, one hour... It would still be a roll.

This isn't like stock where you just hold until you feel like selling... There is a whole dynamic to timing... And there is a lot that goes into making that right timing call, but at some point you have to sell.

I'm not sure if you meant to quote me to tell me this or if this was just meant in general for everyone, but everything you said should be known to anyone who is buying and selling options. If not then they are at a big disadvantage.

My only point is that when rolling up (same expiration date but higher strike price), there will always some loss in doing the transaction so that has to be considered. Rolling out (further out expiration date and technically the same strike price although rolling out and up is better if the stock has gone up) has the same losses but the gain made in having less time decay offsets that.

 

[chickensevil]

I'm not sure if you meant to quote me to tell me this or if this was just meant in general for everyone, but everything you said should be known to anyone who is buying and selling options. If not then they are at a big disadvantage.

My only point is that when rolling up (same expiration date but higher strike price), there will always some loss in doing the transaction so that has to be considered. Rolling out (further out expiration date and technically the same strike price although rolling out and up is better if the stock has gone up) has the same losses but the gain made in having less time decay offsets that.

It was just the way it came across to me at first was like you were saying this was a bad idea. So I thought it should be clarified. But yes, you have to assume you are going to at least make an additional 10$ or whatever your total transaction costs are by rolling up (or even out I suppose). I have seen first hand on how great rolling up can be, but you have to be really careful about doing that since if you miss your new mark you could not only cap out some of your gains, but potentially lose a substantial amount of money. Rolling up (same expiration new price) should ONLY happen if your thesis has substantially changed to give you a strong chance that you will exceed your new target.

Anyway, nothing wrong with your comments just thought the extra clarification would help

 

[pz1975]

It was just the way it came across to me at first was like you were saying this was a bad idea. So I thought it should be clarified. But yes, you have to assume you are going to at least make an additional 10$ or whatever your total transaction costs are by rolling up (or even out I suppose). I have seen first hand on how great rolling up can be, but you have to be really careful about doing that since if you miss your new mark you could not only cap out some of your gains, but potentially lose a substantial amount of money. Rolling up (same expiration new price) should ONLY happen if your thesis has substantially changed to give you a strong chance that you will exceed your new target.

Anyway, nothing wrong with your comments just thought the extra clarification would help

Agree with you again. I didn't mean that rolling up was a bad idea. It is a great strategy if things go up faster than you thought and you still expect more increase and want to leverage that.

I was originally asking Robert.Boston about his thoughts on doing that from 260 to 280 as he wrote, and whether that would be worth doing for such a small difference in strike price (7.7%) knowing there will be some "collateral" losses in doing the 2 transactions.

 

[Auzie]

For very long term options you should always be able to buy for less than the ask and sell for more than the bid. Unless you expect the stock to move very quickly it is usually worth spending a little time setting your bid or ask as high or low as you can and then slowly moving it up/down. At least that is normally my strategy with LEAPS

As for transaction fee it varies a lot but at my broker it really is not enough to matter when talking about LEAPS that are worth thousands.

Agree but you will still usually "lose" a bit when selling one option and buying another. It would be unlikely to be able to sell the 260 for halfway between the bid-ask prices and then get the 280 for halfway again. You are much more likely to sell the 260 closer to the bid price (lower) and then have to buy the 280 closer to the ask price (higher). The cost of doing that + the smaller factor of the transaction fees will eat into the potential profit gain if the stock goes up and worsens the loss if the stock stays the same or goes down.

My experience is that getting into the right trade is far more important than transaction fees. The technique of buying and selling as described by blakegallagher above is quite helpful and usually works.

With TSLA being so volatile, I am testing a strategy that involves selling leaps when stock rises and then buying back different strike and expiration (leaps) when stock goes down. The difference between my new strategy and rolling is that I might get better buy price if I wait for the dip, which usually comes after stock rise.

It would be great to do the same with short-term options, but I am not there yet. I find it very difficult to get into the right trade with short term options. It is easier to get into the right trade with leaps.

There is a risk that stock runs away from me, so I miss on buying new bunch of leaps at a good price. That would not upset me terribly as my core stock holdings appreciates in such scenario.

TSLA seems to travel zig zag upwards, thus there are opportunities to buy back in.

 

[willowspuppy]

I have a DITM Jan '15 call that's up quite a bit. If I roll out, I'm guessing I'll have to pay short-term capital gains on the sell leg? I'm considering just exercising it to avoid that. When you exercise a position, does the cost basis include the premium paid for the option? This is all in a taxable account, obviously.

 

[chickensevil]

Agree with you again. I didn't mean that rolling up was a bad idea. It is a great strategy if things go up faster than you thought and you still expect more increase and want to leverage that.

I was originally asking Robert.Boston about his thoughts on doing that from 260 to 280 as he wrote, and whether that would be worth doing for such a small difference in strike price (7.7%) knowing there will be some "collateral" losses in doing the 2 transactions.

It really depends on what target price you think we will actually hit and how quickly we will hit it. Given the cost of these things, you aren't actually expecting it to be a 260 strike by the time you sell, but rather way above that. So it depends on what Robert actually is conservatively thinking the price will be at within the next couple years. Just for some nice simple examples based on today's prices:

edit: top chart is for 260$ and bottom chart is for 280$, since they aren't labeled... Sorry about that.

You can see that if the price stays low... lets say 316$ by 2016, then rolling up was a bad decision. But as soon as we get up to 344$ it becomes a positive position trade and will continue to be positive going up from there. Jumping backward to like... June 5th, and the trade becomes net positive at 296$ (if we aren't well into the 300s by June I think something might be wrong). Jumping backward to Jan 6, and the trade becomes net positive at 268$.

Couple points: The numbers reflected here is percentages, it would mess up the numbers a little bit if you couldn't get an even exchange for your money e.g. turning 2 contracts @ 15$ into 3 contracts @ 10$ thereby keeping you fully vested at 30$. But overall, if you think the price is going to continue to rise faster than previously anticipated it would certainly be profitable even on the small dollar move from 260-280. Obviously, it would be an even bigger and faster return if you went with a much higher strike, but that carries the risk of not actually hitting those higher numbers. You could argue that 344$ by Jan 2016 is feasible, but say, for example 500$ isn't.

PS: I am not making recommendations on trading any of these strikes or options contracts, just pointing out the logic behind why you might make such a decision. It is up to the individual to determine what final prices seem feasible.

- - - Updated - - -

I have a DITM Jan '15 call that's up quite a bit. If I roll out, I'm guessing I'll have to pay short-term capital gains on the sell leg? I'm considering just exercising it to avoid that. When you exercise a position, does the cost basis include the premium paid for the option? This is all in a taxable account, obviously.

Yes, exercising them is a way to avoid the capital gains, as far as I am aware it continues the same timer so if you bought the contracts in, say, March, you would simply have to hold the stock through March to make it a long term gain.

I don't know the answer to your second point.

 

[Robert.Boston]

To be clear, I'd be rolling $220s up to $280s, which is a big swing. I wouldn't roll up just for a $20 change in the strike price.

 

[pz1975]

As an example of rolling up: back when the stock tanked, I bought some slightly OTM Jan'16 calls. Now with the stock near $260, I'll shortly sell one and move up to, say, $280. Yes, these are conservative plays, being so close to being ITM, but that's where I'm comfortable for now. Doing this roll up lets me double my holding with no extra money on the table, or to pull some profit out. I'll probably leave all the money on the table particularly with the rest of the equities market so overheated.

Rolling out avoids theta decay. It comes at a cost, though, as the longer-dated call will cost more than the shorter-dated call you are selling.

Sorry Robert, I didn't read your post (above) clearly enough last night. I read it quickly and saw "...OTM Jan16 calls...$260...move up to, say $280." and thought you were rolling 260's up to 280, which didn't make sense, hence my question. Rolling $220 to $280 makes way more sense.

 

[Papafox]

Trying to make sense of seller strategies in TSLA Jan 17 calls.
$200 strike price with $90 asking price = $255 (current price) - 90 = $165 net cost of stock for call seller. Seller must hold stock for 1 year. Thus, $200 paid on Jan 17 - $165 net cost = $35 profit/$165 = 21% return / 2 = 10.5% annual return.
The downside would be if TSLA closed lower than $165 and seller lost money during the 2 year period.
$230 strike price with $74 asking price = $255 (current price) - $74 = $181 net cost of stock for call seller. Seller must hold for 1 year. Thus, $230 paid on Jan 17 - $181 net cost = $49 profit/$181 = 27% return / 2 = 13.5% annual return.
The downside would be if TSLA closed lower than $181 and the seller lost money during the 2 year period.
$250 strike price with $66 asking price = $255 (current price) - $66 = $189 net cost of stock for call seller. Seller must hold for 1 year. Thus, $250 paid on Jan 17 - $189 net cost = $61 profit/$189 = 32% return / 2 = 16% annual return.
The downside would be if TSLA closed lower than $189 and the seller lost money during the 2 year period.
$300 strike price with $48 asking price = $255 (current price) - $48 = $207 net cost of stock for call seller. Sell must hold for 1 year. Thus, $300 paid on Jan 17 - $207 net cost = $93 profit/$207 = 45% return / 2 = 22.5% annual return.
The downside would be if TSLA closed lower than $207 and the seller lost money during the 2 year period.

Further, the annual return to seller is increased if the stock closes above the net cost of the stock but below the strike price (and the seller retains the stock). For a particularly volatile stock like TSLA, if I were selling calls I would rather be selling the $300 call instead of the $200 call when return vs. risk is concerned.

 

[InTheShadows]

Trying to make sense of seller strategies in TSLA Jan 17 calls.
$200 strike price with $90 asking price = $255 (current price) - 90 = $165 net cost of stock for call seller. Seller must hold stock for 1 year. Thus, $200 paid on Jan 17 - $165 net cost = $35 profit/$165 = 21% annual return.
The downside would be if TSLA closed lower than $165 and seller lost money during the year.
$230 strike price with $74 asking price = $255 (current price) - $74 = $181 net cost of stock for call seller. Seller must hold for 1 year. Thus, $230 paid on Jan 17 - $181 net cost = $49 profit/$181 = 27% annual return.
The downside would be if TSLA closed lower than $181 and the seller lost money during the year.
$250 strike price with $66 asking price = $255 (current price) - $66 = $189 net cost of stock for call seller. Seller must hold for 1 year. Thus, $250 paid on Jan 17 - $189 net cost = $61 profit/$189 = 32% annual return.
The downside would be if TSLA closed lower than $189 and the seller lost money during the year.
$300 strike price with $48 asking price = $255 (current price) - $48 = $207 net cost of stock for call seller. Sell must hold for 1 year. Thus, $300 paid on Jan 17 - $207 net cost = $93 profit/$207 = 45% annual return.
The downside would be if TSLA closed lower than $207 and the seller lost money during the year.

Further, the annual return to seller is increased if the stock closes above the net cost of the stock but below the strike price (and the seller retains the stock). For a particularly volatile stock like TSLA, if I were selling calls I would rather be selling the $300 call instead of the $200 call when return vs. risk is concerned.

So by your logic, buying those calls is a good idea?

 

[Papafox]

So by your logic, buying those calls is a good idea?

I'm not looking at the buying side of the equation here, I'm only trying to understand the seller's side of the equation. I'm also trying to understand the risks in selling leaps. My general conclusion is that with a stock as volatile as TSLA, I probably don't want to be selling leaps.

I also noticed a mistake I made. In the case of out of the money leaps such as the $300 strike price, having the stock end the option period at a price of $299 might maximize the option seller's profits, but the same would not be true for in-the-money leaps such as the $200 strike price. I have placed this post in the newbie forum because I'm more of a newbie options trader than an advanced trader and by thinking out loud I can perhaps learn something.

Hmm, I'm still trying to wrap my mind around the most profitable outcome for the seller. If the seller of the $300 leap sees the option processed, he received $300. If the stock closes at $299, the seller retains a stock that is valued at $299. In both cases, the seller paid $255 for the stock and received $48 for selling the call. Unless one takes tax consequences into consideration, I am not understanding how the stock closing at $299 would be better for the seller than if it closed at $300.

 

[MikeC]

So why do the new J17s top out at 340 strike price? When can we expect higher strikes to be available?

 

[InTheShadows]

So why do the new J17s top out at 340 strike price? When can we expect higher strikes to be available?

There is not much liquidity in them yet. The ATM options go first then they work their way out from there. If you look at the bid ask spreads for the ATM options and compare them to those at 340 and 200 you will see the further out you go the wider the spread. As the days go on the options will fill in further OTM and the spreads will narrow.

 

[Robert.Boston]

Trying to make sense of seller strategies in TSLA Jan 17 calls.
...
$300 strike price with $48 asking price = $255 (current price) - $48 = $207 net cost of stock for call seller. Sell must hold for 1 year. Thus, $300 paid on Jan 17 - $207 net cost = $93 profit/$207 = 45% annual return.
The downside would be if TSLA closed lower than $207 and the seller lost money during the year.

I'm either confused about what you're asking, or you're confused about how you might make money writing a call.

So let's look at the simplest case: you write a call (=sell a call), you leave it open to expiration, and the stock is not called away before expiration. Let's denote the TSLA price on the date of expiration "Pe".

• If Pe <= $300, you simply keep the $48 premium (plus interest)
• If Pe > $300, your net payoff is 48 - (Pe - 300). Your break-even is P3=$348; technically unlimited loss as the price goes to infinity.

I think what you're thinking of us writing a covered call, i.e. buying 100 shares of TSLA and sell a call. This has completely flipped payoffs compared to the naked call:

• If Pe <= $300, your net payoff is 48 + (Pe - 255); loss limited at 48 - 255 = (207).
• If Pe > $300, your net payoff is 48 - (Pe - 300) + (Pe - 255) = 48 + 300 - 255 = $93. Your break-even is $207 as the price goes to zero.

So in this simple case, you can see that it's bullish to set up a covered call, i.e. buying equity and writing a call: you lose if the price goes down. You lose less badly than if you simply hold the equity--in fact you do better, as long as the equity's price doesn't rise above $348 from its current $255 level. What you give away is upside: if TSLA has a big price increase, you only participate in the first part of the run-up.

Writing a naked call, OTOH, is bearish: you lose if the price goes up (too much). It's less bearish than shorting the stock outright, because you only lose if the stock price goes up by more than the premium you were paid. (To write naked calls you'll need Level 4 option trading rights or the equivalent at your brokerage, and the calls must be in a marginable account. If the price of TSLA goes up, you might end up having to make a margin call. Definitely not a newbie strategy.)

You can't simply conclude that you earn $45% on the call; it all depends on how the stock price plays out.

Hope this helps!

 

[Papafox]

I'm either confused about what you're asking, or you're confused about how you might make money writing a call.

So let's look at the simplest case: you write a call (=sell a call), you leave it open to expiration, and the stock is not called away before expiration. Let's denote the TSLA price on the date of expiration "Pe".

• If Pe <= $300, you simply keep the $48 premium (plus interest)
• If Pe > $300, your net payoff is 48 - (Pe - 300). Your break-even is P3=$348; technically unlimited loss as the price goes to infinity.

I think what you're thinking of us writing a covered call, i.e. buying 100 shares of TSLA and sell a call. This has completely flipped payoffs compared to the naked call:

• If Pe <= $300, your net payoff is 48 + (Pe - 255); loss limited at 48 - 255 = (207).
• If Pe > $300, your net payoff is 48 - (Pe - 300) + (Pe - 255) = 48 + 300 - 255 = $93. Your break-even is $207 as the price goes to zero.

So in this simple case, you can see that it's bullish to set up a covered call, i.e. buying equity and writing a call: you lose if the price goes down. You lose less badly than if you simply hold the equity--in fact you do better, as long as the equity's price doesn't rise above $348 from its current $255 level. What you give away is upside: if TSLA has a big price increase, you only participate in the first part of the run-up.

Writing a naked call, OTOH, is bearish: you lose if the price goes up (too much). It's less bearish than shorting the stock outright, because you only lose if the stock price goes up by more than the premium you were paid. (To write naked calls you'll need Level 4 option trading rights or the equivalent at your brokerage, and the calls must be in a marginable account. If the price of TSLA goes up, you might end up having to make a margin call. Definitely not a newbie strategy.)

You can't simply conclude that you earn $45% on the call; it all depends on how the stock price plays out.

Hope this helps!

Robert Boston, your response was quite helpful. I do indeed need to ponder the covered call vs. naked call difference. As you say, one is essential bullish and the other bearish.

Looking at someone who sold a naked call at a 300 strike price Jan 17 option for $34, that person is going to lose money if the stock ends the period above $334. I am now understanding why some sellers of naked calls for short terms (weeklies, monthlies, etc.) may actually wish to manipulate the stock price a bit on the day the options expire to keep the stock below the strike price plus the price of the option. Such a strategy may make sense for short term naked calls but likely does not make sense for long-term covered calls.

I'm thinking, too, that the seller of the naked call has an incentive to keep the stock price below the strike price on option expiration day because then the option seller doesn't need to have money tied up buying stock and waiting for the option exercising proceeds to come in. Again, I am thinking out loud with an invitation for anyone to see shortcomings in my thought process and speak up. I'm just learning about the seller side of options.