Updated Chart as of 6-30-10
I sold (10) 560/400 GOOG strangles for $1.55. Given the odds of this trade losing money I'm comfortable with the RoR of (1550/50000) = 3.1%. Earnings are on 7/15 after the market close, options expire on 7/16. I plan on exiting before earnings to avoid surprises since I'm exposed big on both sides. Above current price we've got possible resistances at $525, then the 200MA which acted as resistance five times from 4/28-5/3 before it really rolled over, and below we've got recent support three times at $463, and major long-term support at $400. The trajectory lines needed to reach either strike are steep, but the chart surely shows similar moves in the last year. I copied the needed trajectory lines in blue and looked for other areas of similar behavior and found three. However, this would entail the stock needing to immediately head in one of those directions and stay the course, and the stock is clearly in a channel the last six weeks so once again I'm comfortable with the risk. I'm basically risking a game changing unforeseen move. Since earnings can sometimes be that game changer I will look to exit ahead of then.
The buying power needed for the position is $50,000 on TOS, but I don't have that much in that account so I did it at IB. The buying power needed over there is more, something like $75,000. So I'm probably going to transfer the account sooner rather than later. I still like the prices and execution on IB so I've been hesitant. But efficient allocation of capital is a must so I've got to keep that in mind.
I like the probabilities of this play. Looking at the prbability of expirying there is a 4-6% chance that either leg will expire in the money and only a 7-10% of touching. It also has a really nice Theta of $170 a day. It has a very small amount of delta exposure as well as gamma.
ReplyDeleteIf you have the capital I would say this is a good trade. The only thing that I would keep my eye on is the short volatility exposure that you have. I went back to think back to see how the implied volatililty moved in the front month vs the back month before GOOG last earnings and it started at just a few point differential like it is now and by the day of earnings there was a 50 point differential.
Dominic, thank you for the input. I actually did not consult the IV chart for this trade, it was a pure technical play. But that's actually a mistake as part of my trade worksheet is to always look at IV. I've already gotten in the habit of putting trades on and then working them up later.
ReplyDeleteI added two more pictures to the original post so please take a look at those. Here is what I did, I looked at the historical relation of IV leading up to earnings and in the last four quarters, it looks like the increase in IV ranges from 6-10. So on the analysis page of TOS I increased the IV by 10% and then set the date ate two weeks from now. This is a more conservative analysis as in recent history, the 10% max increase in IV hasn't happened until the day of earnings.
But the results are kind of what you'd expect, the increase in IV kind of wipes out the expected theta decay over that time had IV been held constant. Should this occur, it means there is no purpose in entering this trade this early as you could reasonably expect IV to increase. Now if you think it won't, that's another story. So I'm going to follow this closely, daily, and see just what a change in IV does to theta.
I'll wait to see how things play out, but should IV increase and negate the expected theta decay it will be helpful for two reasons. The first is again, no sense in entering the trade early if you expect IV to increase, and second, this particular trade would make much more sense in non-earnings months.
Sincerely I thank you for the input as this will be a great learning trade regardless of what happens.
So I just added a screen shot for the starting greeks of this position from my IB account. I'll plan on updating maybe Friday as we see if IV has increased by then.
ReplyDeleteI have closed out the short put side of this strangle for a push. Here is a retrospective of this trade since I put it on four days ago.
ReplyDeleteThe first mistake is I did not do my due diligence in putting this trade on. I was bearish in general and comfortable selling naked calls on this name for a third month in a row. The main impetus for selling the naked put and turning it in to a strangle sale was that it didn't cost me any more margin power to do so. I was looking at the probabilities and the dollars I could make and that was about it.
It wasn't until Dom's post on this trade that I took a look at the historic relation of IV. This being an earnings month, you should expect a run up in IV. So I started following this daily and indeed, IV is increasing about a point a day. So taking a look at the beginning Theta/Vega relationship, this means you could almost expect the increased vega to wipe out theta, and it did. After four days this position was barely profitable.
So let's look at the situation I got myself in. I'm bearish on the market, so much so that I bought some OTM puts for July expecting a decline. Now I'm short Vega with IV expecting to rise, and short deltas when I'm expecting the market to decline. Being short puts in this instance is the opposite of what you should be doing.
So even though I feel the possibility of GOOG breaking $400 in the next three weeks is very low, I was starting to lose psychological capital over this position. I'm not in position to take ownership of 1000 shares of GOOG, which means the position would have to be closed out early, and by the time that decision would come it would be because the pain was too intense.
So lots of learning experiences on this trade and I got out for the price of commissions, I'll take that. It simply wasn't worth a possible $700 to lose my mind for the next few weeks. If I'm going to enter in to unlimited risk type trades then there needs to be an exit point, this trade didn't have one. By the time the trade were to break the support line, which coincides with the SPX support at 1040, it would be too costly to get out.
I am going to continue to follow the Theta/Vega relationship of this trade and will update at the end of July OPEX.
It is great that you were able to realize this. And flat out good risk managment.
ReplyDeleteI just updated the initial post with today's chart. I had originally drawn a line of where the stock would need to trade from trade inception date to close in order to breach the naked put line. The worse case scenario is slowly coming true. I am so thankful that I listened to my gut and admitted that this trade was too risky for me. It may well close out for no loss, but I can't even imagine the psychological capital I would be losing over this trade. I surely would have closed it once it broke support as the market crashed 3.5% yesterday. That loss would have been about $1000.
ReplyDelete