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"Milking the Cow" Options Strategy


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https://seekingalpha.com/article/4356196-milking-cow-using-options-in-time-of-coronavirus?source=all_articles_title

 

 

I just stumbled across this article on SA from a couple years back, and thought this was a really interesting strategy. I was curious if anyone has tried this, or something similar. 

 

My brief synopsis of the article, essentially he would advocate buying LEAP Call and LEAP put either ATM or OTM (depending on initial outlay vs. possible margin exposure). Then selling weekly calls and puts ATM, then rolling the options at least once week, he suggests after a big move to sell ATM options however far out you have to go to get a credit on the rollout.  If assigned on an option, close that position out immediately and sell a new ATM weekly option. 

 

Concerns I have are that after a big move with a stock you might not be able to roll over the option to get a credit on the rollout. He seems to go through some math and examples about this, but I think I need to spend some more time digesting the strategy. Has anyone done this, or anything similar?  I'm wondering if I misunderstand the strategy, and that the LEAPS and weekly options are BOTH being rolled out on a weekly basis to stay ATM. 

 

I think this is a similar concept to a calendar spread, which he does mention in the article. Overall, I found this to be quite interesting, and glad it's not stuck behind the paywall or I never would have found it. 

Edited by RedLion
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Here is how you lose: say there is a 20%+ move in the stock, even worse a 30% due to a take-out.  You lost money on both sides.  You are effectively short gamma in this strategy.  

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I'll have a better look and maybe do some modeling later, but already found the catch in his example of a SPY trade with long $305 options and SPY dropping to $92:

 

"The long-term put that I still own at a 305 strike price would have gained more than $213. Given the increased volatility and remaining time value in it, it would probably sell for around $290".

 

A $305 put selling at $290 (predicting a drop of the underlying below $15) ... he is modeling a ~350% implied volatility here, which has never happened for the S&P500.

 

The worst VIX spikes we have seen, in 2020, were to 85%. Even a 100% IV would price the put at only $220, making his calculation fall apart.

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In essence it is a double calendar spread, that acts in the short term, when the short options expire, almost the same as a short straddle, because the combined value of the long options does not really change that much unless there are huge moves.
 

image.png.ae411cebb4a36f60c5456b5a6c339c40.png

 

Zooming further out you can see that it is a calendar spread:

 

image.png.af66370add69693f55995d0c87f782ad.png

 

The problem with these trades is that in real life, in realtime, they don't work quite the same as on paper. In the above example, let's say SPY drops to $405 after 2 days, then back to $415 after a week. What do you do at $405, already looking at losses? Do you already roll the options, or do you wait, risking running further into loss territory in a panicky market?

 

Not to mention rare events, like a 10% drop in a week. When those happen, you are again faced with a market call - keep selling the same, now far ITM/OTM strikes for miniscule premiums, or roll them closer to ATM, effectively locking in losses and risking getting whipsawed.

 

In summary, all these short straddle/short premium trades are not as easy in practice, and can be mightily stressful and time consuming for very little reward. Most of the time they work reasonably well for a while, until a rare event wipes out all or most of the accumulated profit.
 

Edited by backtothebeach
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2 hours ago, backtothebeach said:

In essence it is a double calendar spread, that acts in the short term, when the short options expire, almost the same as a short straddle, because the combined value of the long options does not really change that much unless there are huge moves.
 

image.png.ae411cebb4a36f60c5456b5a6c339c40.png

 

Zooming further out you can see that it is a calendar spread:

 

image.png.af66370add69693f55995d0c87f782ad.png

 

The problem with these trades is that in real life, in realtime, they don't work quite the same as on paper. In the above example, let's say SPY drops to $405 after 2 days, then back to $415 after a week. What do you do at $405, already looking at losses? Do you already roll the options, or do you wait, risking running further into loss territory in a panicky market?

 

Not to mention rare events, like a 10% drop in a week. When those happen, you are again faced with a market call - keep selling the same, now far ITM/OTM strikes for miniscule premiums, or roll them closer to ATM, effectively locking in losses and risking getting whipsawed.

 

In summary, all these short straddle/short premium trades are not as easy in practice, and can be mightily stressful and time consuming for very little reward. Most of the time they work reasonably well for a while, until a rare event wipes out all or most of the accumulated profit.
 

 

 

Thank you! This is exactly the type of thing I was worried about, locking in losses by selling ATM puts/calls on a position that's already moved against you. I think maybe the theory is that if you keep selling ATM options, eventually the premiums would make up for any losses. I reread the article, and he is indicating holding the LEAPS to expiration and keep writing weeklies, so this seems like it really could set up a whipsaw with a big move in the stock.

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Just to play around with this idea I went ahead and bought a 1 LEAP call and put on APO, for an outlay of $2,650. My Call is ITM by $10 which I chose because I'm bullish on the stock. The put is just OTM. 

 

Sold slightly OTM put/call expiring next Friday for $160, and will start looking for opportunities to roll these. If I could do this every week it would take about 10 weeks to earn back the time value on my LEAPS (there's $1,000 of intrinsic value on the CALLS since I wanted to express this as slightly bullish on the underlying.

 

Will be interesting to see how this plays out in reality, I think this would be much better on index ETFs, but I wanted to play with something small and my outlay is essentially $2,650 with $1,000 of intrinsic value on a call that I think should work out over time. I'll post some updates here as I play with the strategy.  

 

 

For the first round, I bought:

 

1/19/24 CALL $47.50 - $16.50

1/29/24 PUT $57.50 - $10.20 

 

$2,672.65 (after commissions) 

 

Then Sold

 

8/12/22 CALL $59 - $85

8/12/22 PUT $56 -  $75

 

$158.70 (after commissions) 

 

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14 hours ago, Dinar said:

Here is how you lose: say there is a 20%+ move in the stock, even worse a 30% due to a take-out.  You lost money on both sides.  You are effectively short gamma in this strategy.  

 

So let's say there's a takeout offer for a big 30%+ premium. Presumably the LEAP put will lose more than the LEAP call gains because there would be a big move in the stock presumably accompanied with a reduction in volatility? It seems like the biggest risk would be for a big move right after putting on the position before being able to recoup the LEAP premiums by selling weeklies? 

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58 minutes ago, RedLion said:

 

So let's say there's a takeout offer for a big 30%+ premium. Presumably the LEAP put will lose more than the LEAP call gains because there would be a big move in the stock presumably accompanied with a reduction in volatility? It seems like the biggest risk would be for a big move right after putting on the position before being able to recoup the LEAP premiums by selling weeklies? 

Your leap put that you are long will lose more than the short-term put that you are short.  Your long term call leap will go up less than the short-term call that you are long.  That's correct, you lose if there is a sharp sudden move early on.  

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LOL, I can see your trades on IB. Looking forward to seeing it develop.

 

With unchanged volatility I get this risk graph, with breakevens at $55.33 and $62.09.

image.png.fd628f69a32d97ffbbe4c2d0ff35db59.png

 

<<< the biggest risk would be for a big move right after putting on the position

<<< before being able to recoup the LEAP premiums by selling weeklies? 

 

Exactly, In case of a firm takeover bid and huge move towards the takeover price before August 12, implied volatility would surely be cut at least in half (the red line), with the LEAPS losing most of their time value before you had a chance to recoup it.

 

image.png.712babedb63934873988885792b2222a.png

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This is super neat and I love this academic exercise with real world $$$ attached to it. This looks like a double diagonal spread but the way you structured your trade your strike prices will result in a bit of overlap causing it look like a busted up single diagonal. I think if you do the calculations you'll be mostly gamma neutral (long on long call/long put and short on short call/short put) but you are long vega (volatility). Few general comments:

 

1) I would put on this position when the stock trades with HV > IV. So right after earnings when all the volatility comes down. You are basically betting that weeklys will worth more as you are approaching earnings. 

2) The position you built is leaning bullish so you will probably be better off having just one diagonal (call side) and just keep rolling up or down but I am super curious how this plays out.

3) When you sell ATM options, you are taking lowest IV value (assuming it fits the volatility smile) so you may modify your trade to get paid a bit more for essentially same risk profile.

4) You are spot on with big moves. Pick a big co that's unlikely to be acquired (e.g., Google) and you can mitigate this risk.

 

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On 8/5/2022 at 6:29 AM, lnofeisone said:

This is super neat and I love this academic exercise with real world $$$ attached to it. This looks like a double diagonal spread but the way you structured your trade your strike prices will result in a bit of overlap causing it look like a busted up single diagonal. I think if you do the calculations you'll be mostly gamma neutral (long on long call/long put and short on short call/short put) but you are long vega (volatility). Few general comments:

 

1) I would put on this position when the stock trades with HV > IV. So right after earnings when all the volatility comes down. You are basically betting that weeklys will worth more as you are approaching earnings. 

2) The position you built is leaning bullish so you will probably be better off having just one diagonal (call side) and just keep rolling up or down but I am super curious how this plays out.

3) When you sell ATM options, you are taking lowest IV value (assuming it fits the volatility smile) so you may modify your trade to get paid a bit more for essentially same risk profile.

4) You are spot on with big moves. Pick a big co that's unlikely to be acquired (e.g., Google) and you can mitigate this risk.

 

 

I like experimenting with real $$$. I think of it as tax deductible tuition with an attached lottery ticket. In this case, $2,653 is my maximum loss which would almost certainly be a short term loss. I certainly don't have down all the mechanics, as I've said I'm more of a novice or perhaps intermediate options trader (most experience is with selling puts, buying leaps or doing bull call spreads over the last 10 years) and I would like to start researching more complex options strategies, really put in the work to understand the greeks, and learn more about using software to evaluate trades. 

 

1) So I put the trade on the day of earnings after they had been released, I wish I could say this was by design, but it just worked out that way when I started this topic

2) So the idea would be don't own the LEAP put at all? Just sell naked weekly puts, if I can't roll them over and I get assigned the stock, I would just sell the stock and sell another weekly put? I had actually considered this idea anyway since I hate spending $10 on downside protection I think will be worthless by options expiry (although I'm certainly wrong often enough). If I'm understanding you right on this I would be using margin to buy APO if puts got exercised, but I could basically just sell that right away and keep selling weekly puts ATM? 

3) So collecting more premium by selling ATM instead of just barely OTM? This is where my lack of understanding the greeks comes to bite me. I've always had a very novice way to handle this where I look for the strike furthest OTM that will provide >1% return on the collateral for the put, this is probably holding my returns down in these strategies.

4) Now I understand why SPY would be ideal for this strategy. But stocks like META, GOOGL, MSFT, BRK.B, AAPL, and BX I would never see getting acquired, and they're probably a hell of a lot more liquid than APO options as well. Depending on how this first experiment goes I might delve into some of the above names or just SPY/QQQ.  

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So for 2 you would do just the call diagonal. You may need to play around with good strike prices.

3) ATM will give you lowest IV premium. If you go up a bit to OTM, you'll collect a bit more premium for generally same risk profile, especially on weeklys.

4) Doing index vs. individual companies has pros and cons. Index - you won't get the risk of being acquired but there is no earnings premium on indices. With index, you have to track overall volatility probably via VIX and put on your position when VIX is low and sell weeklys when VIX is high. Economic calendar will be your friend. Companies - you have a risk of being acquired but you can collect fat premiums around earnings and have volatility crush further boost your return profile.

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I made my first trade today since putting on this position, I'm still learning here, so this may have been the wrong move. As I've mentioned in a previous post, I consider this experiment tuition, so hopefully by the time I learn a lot more about options strategies I can start allocating a larger percent of my net worth into these situations. 

 

APO (and the rest of the market) had a big move today, so my short $59 call expiring on Friday is underwater pretty significantly. I bought this call back for $1.58 ($158 since I'm only doing this position with 1 contract at a time) and sold the September 23 $62 CALL for $1.85 for a total credit of $25.70 after commissions. I realized a loss of $74.30 on buying back the $59 call, and the other positions are sitting at unrealized $79.90 in gains. So 4 trading days in and this strategy is pretty much flat in the face of a 5% move in the stock. 

 

I'm not sure if I should have tried to go for lower strike prices closer to the money, but I prefer the idea of rolling my strike price up. The downside, I won't be able to write another call for about 6 weeks unless I'm able to buyback the one I just wrote. 

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@RedLion - this is awesome to see the theory combine with practice like that. My only suggestion is to roll your trades on the Friday of expiry around 3PM or so. This way you pay 0 for time value  when you close a leg(so theta = 0). Rolling strike prices higher makes sense, as long as you are at least 1 or 2 strikes away so you get paid more for volatility. Just my 2 cents and have I have no money in this trade :).

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24 minutes ago, lnofeisone said:

@RedLion - this is awesome to see the theory combine with practice like that. My only suggestion is to roll your trades on the Friday of expiry around 3PM or so. This way you pay 0 for time value  when you close a leg(so theta = 0). Rolling strike prices higher makes sense, as long as you are at least 1 or 2 strikes away so you get paid more for volatility. Just my 2 cents and have I have no money in this trade :).

 

This makes sense. I'll probably roll my put this Friday, and take no action on the call I just sold for now. 

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My $56 8/12 put expired worthless, so I sold a $59 put expiring 8/19 for $0.50. Currently we are sitting at $98.10 in profit on this strategy, will see how long this holds.  I will continue to post whenever I make any trades. 

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So I decided to add one more position to the experiment to try this with SPY. 

 

I started a $430 straddle expiring December 20, 2024 for a total outlay of $11,701.30 after commissions, $117.013 per contract. 

 

Sold a $428 PUT expiring tomorrow for proceeds of $93.35 after commissions and a $431 CALL also expiring tomorrow for $110.35. 

 

I think the index ETFs might be a great choice for this strategy for a few reasons. 1) Tons of liquidity, 2) no takeout risk as mentioned earlier in the thread, 3) even shorter expiration options for the "write" leg of the strategy. 

 

At this point I've committed a little under $15,000 to this experiment, so I think I will see how it goes over several months before increasing my exposure anymore. 

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19 hours ago, RedLion said:

So I decided to add one more position to the experiment to try this with SPY. 

 

I started a $430 straddle expiring December 20, 2024 for a total outlay of $11,701.30 after commissions, $117.013 per contract. 

 

Sold a $428 PUT expiring tomorrow for proceeds of $93.35 after commissions and a $431 CALL also expiring tomorrow for $110.35. 

 

I think the index ETFs might be a great choice for this strategy for a few reasons. 1) Tons of liquidity, 2) no takeout risk as mentioned earlier in the thread, 3) even shorter expiration options for the "write" leg of the strategy. 

 

At this point I've committed a little under $15,000 to this experiment, so I think I will see how it goes over several months before increasing my exposure anymore. 


SPY options are among the most liquid of all, which helps with the bid-ask spread.

 

However it also means that they are usually efficiently priced, the entirety of the option chain being a balanced system of risk and reward (that's how I see it anyway).

 

What would you say is your edge?
 

Edited by backtothebeach
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1 hour ago, backtothebeach said:


SPY options are among the most liquid of all, which helps with the bid-ask spread.

 

However it also means that they are usually efficiently priced, the entirety of the option chain being a balanced system of risk and reward (that's how I see it anyway).

 

What would you say is your edge?
 

 

I definitely don't have an edge, at this point I'm just experimenting. As a novice, I would say the calendar spread strategy maximizes time decay (theta) in general. This is literally just a straddle calendar spread, so in theory, it should be able to profit in an up, down, or sideways market over a period of time as the time decay on the short term options is much higher than the LEAPS.

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Made some trades already with the SPY options.

 

Rolled my $428 PUT expiring today to a $424 PUT expiring on August 24 (one week) for a net credit of $0.16. 

 

Rolled the $431 CALL expiring today to a $429 CALL expiring in 2 days for a net credit of $1. 

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APO: 

 

Rolled the $ 59 APO put expiring today down to a $57 strike expiring September 9 for a $0.17 net credit.

 

Net realized gain so far ($85.25)

Unrealized gain $66.90

 

So far this position was in the black until today. I think it's going to take a couple months until we can really tell if this strategy is working as I collect more time decay on the short term options sales. 

 

 

SPY:

 

rolled my expiring SPY $429 call down to $423 expiring on 8/22 for a $1.65 net credit

 

Net realized gain (29.25)

Net unrealized (120.8)

 

So both sitting on losses at this point, I do think that most likely these should dissipate over time as I collect more premiums on the short weekly options. But we will see. 

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  • 2 months later...

I feel bad for letting this experiment die on the vine. I ended up closing these positions out on vacation in early September because I couldn't keep up with the frequent trading, then I planned to put them back on once I was finished so I could start posting again. But then the market fell into a free fall, and I should have started again because I suspect all this volatility would have been very interesting to see if the strategy worked. I will go back through and look at my trades to see if I can come up with final profit and loss on this strategy, I believe I cleared a very negligible profit, but that was probably user error. 

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22 hours ago, backtothebeach said:

No problem, that was a well-timed vacation! The SPY position would have been a headache for sure.
 

You're telling me! I kept up with the trades the first few days of the vacation and decided I just needed to focus on living up my beach time. Better lucky than good they say. I think I may have lost money one the SPY position but very minimal, and actually made money on APO. I think I will probably try something like this again, but I really don't like having to roll options on a daily or weekly basis. 

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