The options used in Part 1 expired last week and now it’s time to check the results. But before we get there I’ll go through the early management opportunities which were available.
Short options positions usually require some form of intervention to improve capital utilisation and to reduce Gamma risk.
If you don’t want to get the best value for money from your capital scroll down to the Options Expiration section and then the Conclusion. Otherwise just carry on reading.
Options positions management
You can improve the performance of short legs by closing the position early. Sometimes an option can lose 50% of its value within a week. This is a great opportunity to move on and get more return out of your capital.
For example, you can sell a 45 day contract for $1.00 and gain $100 at expiration. However, if you can realise 50% on day 10 you can close the position and sell another $1.00 contract. If the market conditions are suitable and you manage to do this 3 times within the 45 day period you’ll earn $150 instead of $100.
41 Days to go
I am writing this section as the numbers emerge in an attempt to reduce bias. Any conclusion will be inaccurate if I write it with the knowledge of how events unfolded.
Currently the energy sector remains risky so I don’t know what will happen with XLE. Everything you read here is probabilistic: it will go up, down or trade sideways. Here is the options chain:
Thankfully there’s nothing terrible going on. The initial price was $28.92 so XLE is up a penny.
Short Put Option
The $27 strike put is trading for $0.75 per option, consistent with my bad feeling about paying for it. However, if you sold it you’re up $1.10 – $0.75 = $0.35 per share or 1.2%.
I don’t think that there are any clear guidelines but it’s 32% of the max profit of the short put so I’d be happy to close it and sell something else. Nevertheless, it is not unreasonable to leave it a bit longer too.
On this occasion it depends on the other opportunities which are available. If I can utilize the capital for something else I’ll close it. Otherwise, I’ll leave it a bit longer.
The $31 call has made about $0.25 per share. I’d leave it a bit longer unless it was a fear driven transaction in first place.
It’s now around $1.05 which means $0.79 gain per share. That’s not bad, it lost 43% of its value and brought a 2.73% overall gain.
I’d be quite happy to close the $25 strike put to realise $0.71 per share (2.45%) and eliminate the exposure. If I wanted to get rid of the shares I’ll definitely leave the $31 strike call, otherwise just close the strangle.
So far the $28 strike straddle is the winner with a gain of $1.05 (25%) due to depreciation of the short put. It’s a 3.63% overall gain.
If I were you I’d collect my money and run away. We got $105 from the straddle within 9 days, an excellent outcome.
The Collar & Stock Replacement
These positions sit on a paper losses. We’ll leave them alone for the time being.
21 Days to expiration
We have an unexpected turn of events! Who would have thought that Pfizer will come up with a vaccine. The US election is over, volatility is down and stocks are through the roof.
Will the rally hold? Your guess is as good as mine.
As for our stock defence, all the short call strikes are breached. If this happens in real life you’ll get a feeling of regret.
You start making counterfactual assumptions like I would have made more money had I not sold the call.
I stand against hindsight trading. The fact that you sold a call means that you set up the strategy with a prior belief that the stock won’t go up that much.
Well it did, new information came out. You can only trade on the best available information at the time of trading. None of us are clairvoyant.
In terms of management you just sit and wait, there’s nothing to do besides closing any short put legs.
The stock replacement is today’s winner
This is exactly how this strategy is supposed to work in the best case scenario. The outcome could have been different if the vaccine was announced after expiration.
We have 92 shares bought for $28.92 each and two $30 strike calls which were $120 each and funded by the sale of 8 shares. Total investment $2900.64.
So you make $908.96 from the shares and 2x $750 from the options if you sold everything today. The total is $2408 or 83%. I think it’s a great time to close the position.
The put option
The $27 strike put is almost worthless. If you bought it you can just leave it alone, otherwise close it if you have not done so already.
All of these involve a short call option. The Covered Call, Protective Collar, Straddle and Strangle are moving towards max profit unless the latter two were closed at the first opportunity (41 days to go).
This emphasises the importance of position management. It’s better to collect 50% of max profit from a Strangle or 25% from a Straddle in 10 days than to wait another 20 to see the position go against you or to miss out on additional profit.
Today is expiration Friday, time to find out which are the winners and losers. Here’s XLE 1 hour into the morning session:
The results are similar to 21 Days to go, thus supporting the early management approach. Here’s the summary:
|Position*||Initial Cost||Realised Gain||% Gain|
All of the strategies performed as expected. The positions with short call legs underperformed because of the outsized up-move. Nevertheless, all of them realised their max profit. Results would have been different if the stock traded flat or lost value.
The winners are the stock replacement followed by the short put. Both of these preserved the upside gains at the cost of downside risk.
Most importantly, none of the strategies lost money, even the long put! Therefore options remain a versatile tool which can compliment stock positions in various ways.
The key takeaway from this study is that early position management can increase returns and improve capital utilization.