Tuesday, January 24, 2006
Option Analysis
This will be the final part of this. We concluded the last option post with the puts and what happened after the crash of last Friday. The only fault that I can really find is that I used credit spreads that were worth too little in value and I was a little aggressive on the debit spreads. That's OK. I might go back and change the credit spreads to make them more realistic. Regardless, we will finish this until maybe this Friday. I will try to keep tabs on some options trades but I will only do it once a week unless something really moves. For the most part trading option is like watching paint dry or like watching a block of ice melt... like time decay.
I will look at the combined credit spreads first. The Call credit spread we sold for 85 dropped to 35. A net gain of 50.
The put credit spread that we sold for 80 went to 180. Net loss of 100 but it wouldn't have hit my stop. I usually put a stop on the short position for 6 times what I sold it for.
The net between the 2 credit spreads was a loss of 50. Really not bad but you can see the benefits of trading spreads... they will limit your loss over just naked positions.
On to the Debit spreads. The debit call spread cost us 610 and after Friday it was worth only 415. A loss of 195.
The debit put spread we paid 670 for went to 790. A gain of 220. Take into account the loss of 195 and you have a net gain of 25. Not much but again you can see the benefit of trading spreads.
I want to take a quick look at these trades as if we had just sold the naked options.
If we only sold the Mar 1375 call for 110 and it dropped to 55 we would have gained 55. If we had only sold the Mar 1125 for 120 and watched to rise to 280, we would have had a loss of 160. Net the 160 loss on the puts against the 55 gain on the calls and you can see the total loss was 105. Twice what the spread lost.
Let's do the same with the debit spread. If we had sold the Feb 1310 for 740 and let it go to 255 we would have gained 485. Not bad for 3 days work... but wait. We also sold the Feb 1270 for 950 and it went to 1930! Opps A loss of 980 and even after the call gain of 485 you still lost 495! That is pretty serious! We gained money from the spread but lost money if we had sold the shorts naked. A lot of money. The reason? The long increased in value faster as the options went into the money.
If this example doesn't tell you why you only want to trade spreads then I don't know what will!
Maybe we will talk about diagonal spreads next week?
Trader X.
I will look at the combined credit spreads first. The Call credit spread we sold for 85 dropped to 35. A net gain of 50.
The put credit spread that we sold for 80 went to 180. Net loss of 100 but it wouldn't have hit my stop. I usually put a stop on the short position for 6 times what I sold it for.
The net between the 2 credit spreads was a loss of 50. Really not bad but you can see the benefits of trading spreads... they will limit your loss over just naked positions.
On to the Debit spreads. The debit call spread cost us 610 and after Friday it was worth only 415. A loss of 195.
The debit put spread we paid 670 for went to 790. A gain of 220. Take into account the loss of 195 and you have a net gain of 25. Not much but again you can see the benefit of trading spreads.
I want to take a quick look at these trades as if we had just sold the naked options.
If we only sold the Mar 1375 call for 110 and it dropped to 55 we would have gained 55. If we had only sold the Mar 1125 for 120 and watched to rise to 280, we would have had a loss of 160. Net the 160 loss on the puts against the 55 gain on the calls and you can see the total loss was 105. Twice what the spread lost.
Let's do the same with the debit spread. If we had sold the Feb 1310 for 740 and let it go to 255 we would have gained 485. Not bad for 3 days work... but wait. We also sold the Feb 1270 for 950 and it went to 1930! Opps A loss of 980 and even after the call gain of 485 you still lost 495! That is pretty serious! We gained money from the spread but lost money if we had sold the shorts naked. A lot of money. The reason? The long increased in value faster as the options went into the money.
If this example doesn't tell you why you only want to trade spreads then I don't know what will!
Maybe we will talk about diagonal spreads next week?
Trader X.
