Someone Teach Me To Be Fu*king Greedy!

[Guest Dazel]

 

Is he not more famous for saying he buys when there is "blood in the streets".....

 

 

Which is what Sanjeev did! Well done!

 

 

Dazel.

[TwoCitiesCapital]

Sanjeev,

 

I was wondering if you could elucidate your approach to these options. I'm fascinated with options and have tentatively been trying out different strategies as I learn about them over the past 3 years. My two favorites are to go long deep, LEAP call options to get get a delta of 1 to the common stock with less money down or to buy way out of the money calls/puts in a binary outcome type situation. That being said, I have yet to ever make any significant returns using options and have typically ended flat or at a loss. I'm curious to know why you picked the options over common and what your thought process was on the risk/reward of the situation.

 

Thanks for any insight

[twacowfca]

Sanjeev,

 

I was wondering if you could elucidate your approach to these options. I'm fascinated with options and have tentatively been trying out different strategies as I learn about them over the past 3 years. My two favorites are to go long deep, LEAP call options to get get a delta of 1 to the common stock with less money down or to buy way out of the money calls/puts in a binary outcome type situation. That being said, I have yet to ever make any significant returns using options and have typically ended flat or at a loss. I'm curious to know why you picked the options over common and what your thought process was on the risk/reward of the situation.

 

Thanks for any insight

 

I can't speak for Sanjeev, but there is a general answer to your question.  Buying options is usually a losing game like playing the horses. The transaction costs, especially the difference between the bid and the ask, will attrit your capital if you don't have a big edge. 

 

Playing the earnings release game with short term options is a crowded field.  You will lose big time if you don't have insights.  One way to get an edge  is to understand a company extremely well, especially a company that doesn't give guidance and isn't followed by a flock of analysts.  Then, only trade on those rare occasions when you know something big will happen and Mr. Market doesn't.  How do you know what Mr. Market is thinking?  Again, that comes from studying not just the company, but Mr. Market's perception of that  company over time. 

 

Another way to make money with options is to understand what drives the profitability of a company over time and rarely, when there is a row of green lights ahead that Mr. Market can't see, buy leaps if they are attractively priced.  Leaps are typically more likely to be dramatically mispriced than short term options.

 

 

There is another reason to be very selective when buying options: it's a negative sum game for the buyers and a positive sum game for the sellers.  Why is this so?  The sellers make money on average because they are selling volatility, and volatility always regresses to the mean until there is an end of the world event, something that kills the whole system.  Therefore, in a functional system, the buyers of options lose money on average for every trade in addition to the frictional or transactional costs.

 

Therefore, option buyers, like parimutuel bettors on a horse race that have to overcome the rakeoff on every race, must be very selective and only bet when they have an objective and substantial edge over Mr. Market.

 

[Parsad]

Sanjeev,

 

I was wondering if you could elucidate your approach to these options. I'm fascinated with options and have tentatively been trying out different strategies as I learn about them over the past 3 years. My two favorites are to go long deep, LEAP call options to get get a delta of 1 to the common stock with less money down or to buy way out of the money calls/puts in a binary outcome type situation. That being said, I have yet to ever make any significant returns using options and have typically ended flat or at a loss. I'm curious to know why you picked the options over common and what your thought process was on the risk/reward of the situation.

 

Thanks for any insight

 

I don't do anything fancy like many people.  I view options in the same way I view the stock, but I weight the time arbitrage risk against the possible reward from the market mispricing.  The only way to do this is to run through the events that could affect the stock by understanding the psychological aspect of investing. 

 

What is the impact of the quarterly report being poor, and how much do I lose?  What is the impact of the quarterly report being about the same as past years, and what is the possible upside?  What if the quarterly report is very good, how would the market reaction be and how much would the stock rise relative to intrinsic value?  What is the ratio between loss of capital and the upside?  If this report is not good, how much time would the company require to improve performance?  Etc, etc.

 

This tends to work best with companies where there is a significant short position and tighter liquidity.  Companies that have more than adequate short-term capacity to cover their debt maturities.  Also, businesses where you have some aptitude for the industry, how it operates, the business cycles, misinterpretation of data, etc.  I think we've made money on about 60% of our option bets over the years...a little less than equities which is around 65-70%. 

 

We also tend to bet big on the good ideas...1-2% of the fund...and usually never more than 4-5% of the fund in options.  The shorter duration the bet, the less we put in generally.  While we would never have more than 4-5% invested in options at cost, an idea can easily grow to be more than that.  For example, our options on Steak'n Shake at one point grew to almost 18% of the fund from a 3% position...we kept paring it back and it kept growing...over about a year.  This Overstock bet and the Bank of America bet we did a little while ago, both went over 5%, even though we only put 1.5% and 1% of capital into each idea respectively.  But I've never made that much money in such a short time span.  It's just the way it goes sometimes as the market rationalizes something. 

 

Plenty of analysis, but a bit of luck in it too with the time arbitrage!  You just try and make good calculated bets.  I can't remember where I read it, whether it was Tim telling me, or I read it in Peter Cundill's book, but the one thing Cundill did that was very impressive was that he always found different ways to make money. 

 

We're inundated with the culture of value investing a la Buffett...good businesses with competitive advantages...but Buffett over his life has always made money not by sticking to a single philosophy, but by finding irrational and mispriced assets, regardless of anything else.  It's why so many say Buffett contradicts himself.  It's not double-speak as some like Doug Kass allude to at times, but that Buffett understands his ability to exploit inefficiencies.  He also understands that most people cannot do it.  It's also the foundation of Ben Graham's philosophy...buy when irrationality and inefficiencies exist and you have some margin of safety.  It's why Buffett makes the index swaps bet, or the negative coupon Berkshire bonds, or Blue-chip Stamps which led to everything else.  He looks to exploit irrational behavior.  Prem does this too but won't admit it...credit default swaps, deflation hedges, RIMM, etc.

 

I think you have very good examples of people on here that can do that as well.  Not everyone, but you do have a handful of people who are very good at it.  Ericopoly is on one extreme.  He found huge inefficiencies he exploited with gigantic amounts of leverage and concentration.  It took a great deal of analysis, alot of luck on the time arbitrage, and dinosaur-sized balls!  But as you can see from Eric's posts, he spends an inordinate amount of time focusing on risk control and market psychology.  He's got both the science and art side of investing going, and he's got the perfect temperament to handle the leverage and concentration.  So that is how we view options...the same as equities, but constantly recalculating the time arbitrage risks and how the market might behave.  Cheers!

[twacowfca]

Sanjeev,

 

I was wondering if you could elucidate your approach to these options. I'm fascinated with options and have tentatively been trying out different strategies as I learn about them over the past 3 years. My two favorites are to go long deep, LEAP call options to get get a delta of 1 to the common stock with less money down or to buy way out of the money calls/puts in a binary outcome type situation. That being said, I have yet to ever make any significant returns using options and have typically ended flat or at a loss. I'm curious to know why you picked the options over common and what your thought process was on the risk/reward of the situation.

 

Thanks for any insight

 

I don't do anything fancy like many people.  I view options in the same way I view the stock, but I weight the time arbitrage risk against the possible reward from the market mispricing.  The only way to do this is to run through the events that could affect the stock by understanding the psychological aspect of investing. 

 

What is the impact of the quarterly report being poor, and how much do I lose?  What is the impact of the quarterly report being about the same as past years, and what is the possible upside?  What if the quarterly report is very good, how would the market reaction be and how much would the stock rise relative to intrinsic value?  What is the ratio between loss of capital and the upside?  If this report is not good, how much time would the company require to improve performance?  Etc, etc.

 

This tends to work best with companies where there is a significant short position and tighter liquidity.  Companies that have more than adequate short-term capacity to cover their debt maturities.  Also, businesses where you have some aptitude for the industry, how it operates, the business cycles, misinterpretation of data, etc.  I think we've made money on about 60% of our option bets over the years...a little less than equities which is around 65-70%. 

 

We also tend to bet big on the good ideas...1-2% of the fund...and usually never more than 4-5% of the fund in options.  The shorter duration the bet, the less we put in generally.  While we would never have more than 4-5% invested in options at cost, an idea can easily grow to be more than that.  For example, our options on Steak'n Shake at one point grew to almost 18% of the fund from a 3% position...we kept paring it back and it kept growing...over about a year.  This Overstock bet and the Bank of America bet we did a little while ago, both went over 5%, even though we only put 1.5% and 1% of capital into each idea respectively.  But I've never made that much money in such a short time span.  It's just the way it goes sometimes as the market rationalizes something. 

 

Plenty of analysis, but a bit of luck in it too with the time arbitrage!  You just try and make good calculated bets.  I can't remember where I read it, whether it was Tim telling me, or I read it in Peter Cundill's book, but the one thing Cundill did that was very impressive was that he always found different ways to make money. 

 

We're inundated with the culture of value investing a la Buffett...good businesses with competitive advantages...but Buffett over his life has always made money not by sticking to a single philosophy, but by finding irrational and mispriced assets, regardless of anything else.  It's why so many say Buffett contradicts himself.  It's not double-speak as some like Doug Kass allude to at times, but that Buffett understands his ability to exploit inefficiencies.  He also understands that most people cannot do it.  It's also the foundation of Ben Graham's philosophy...buy when irrationality and inefficiencies exist and you have some margin of safety.  It's why Buffett makes the index swaps bet, or the negative coupon Berkshire bonds, or Blue-chip Stamps which led to everything else.  He looks to exploit irrational behavior.  Prem does this too but won't admit it...credit default swaps, deflation hedges, RIMM, etc.

 

I think you have very good examples of people on here that can do that as well.  Not everyone, but you do have a handful of people who are very good at it.  Ericopoly is on one extreme.  He found huge inefficiencies he exploited with gigantic amounts of leverage and concentration.  It took a great deal of analysis, alot of luck on the time arbitrage, and dinosaur-sized balls!  But as you can see from Eric's posts, he spends an inordinate amount of time focusing on risk control and market psychology.  He's got both the science and art side of investing going, and he's got the perfect temperament to handle the leverage and concentration.  So that is how we view options...the same as equities, but constantly recalculating the time arbitrage risks and how the market might behave.  Cheers!

 

That's a lot of great insight, Sanjeev. 

 

Let me pick out and emphasize one of the most important of your observations that can lead to huge gains.  That's a large short interest.  The short sellers, like 'em or hate 'em, are generally right, at least in the short term.  But when they are wrong, taking the other side of their trade can capture a huge reversal when short covering kicks in.  Think Fairfax a few years ago or Overstock now. :)

[ItsAValueTrap]

The short sellers, like 'em or hate 'em, are generally right, at least in the short term.

Aren't they generally right in the long term???

 

Take Michael Burry or any of the subprime CDS guys for example.  It took a few years for the "short the housing bubble"-type trades to work out.

 

2- A lot of short covering has nothing to do with fundamentals.  Look at Volkswagen for example (or CMEDQ).  A lot of the time, short sellers have to cover to manage risk or because they are literally forced to cover because of buy-ins.

 

I do agree that very high short interest can cause crazy short covering.  A tight borrow makes buy-ins a lot more likely.  (And some hedge funds go out of their way to engineer these buy-ins.  Apparently Goldman admitted to giving out information on the borrow situation for particular stocks to help their hedge fund clients do this.)

[bobp]

Sanjeev - For being so generous with your insights, you and a bunch of others here deserve to make five times your money. Great job!

[Aberhound]

Great work Sanjeev. I admired your options analysis on both the BoA and this stock. You have to have the detailed knowledge of the company and understanding of the industry to be ready to pounce.

 

Let me guess one of your next option plays. BBRY has the same large short interest and upside potential, probably on the next earnings report (although I lack the depth of knowledge you demonstrate your comments for Dell and Overstock that there is scope for plenty of earnings for a smaller player in a niche seem to apply here as well). If so, how would your strategy work in terms of the choice of the option strike price and expiry date and time of purchase?

[sampr01]

Wow.. Sanjeev.. You killed the Overstock options trade.. i wish had your luck on short term options...they always stink for me...Please let us know your next options trade.. :-X

In the last few days, I made one of the greatest trades of my life...perhaps one of the greatest trades on this board ever.  Five days ago, I bought Overstock May '13 $12.50 calls.  The stock was getting killed because of the markets, I thought they should make at least as much money as they did last year.  They killed the earnings instead!  I sold my options for five times the money in four days after buying them.  Today, the god-damn thing is up nearly another $3.50, and those options are now worth 15 times what I paid...I'm crying right now...really it hurts like a bitch!  :-X  I had bet reasonably big too...1.5% of the fund in the options!  Whhhhhaaaaaaaaaaaaaa!  Cheers!

[Parsad]

Great work Sanjeev. I admired your options analysis on both the BoA and this stock. You have to have the detailed knowledge of the company and understanding of the industry to be ready to pounce.

 

Let me guess one of your next option plays. BBRY has the same large short interest and upside potential, probably on the next earnings report (although I lack the depth of knowledge you demonstrate your comments for Dell and Overstock that there is scope for plenty of earnings for a smaller player in a niche seem to apply here as well). If so, how would your strategy work in terms of the choice of the option strike price and expiry date and time of purchase?

 

Yes, that is the type of company that it could work for.  I don't follow BBRY as closely, but understanding what their sales trends have been over the last few months, and the progress of their products would be useful.  I suspect this earnings report will surprise, but once the Q10 comes out, I think that will do even better.  There is a hard-core group of Blackberry users waiting for the physical keyboard phone.  There is no other real product out there like that, as everyone is moving to the touch keyboard.  So Blackberry could enjoy a significant short squeeze, not unlike the one we've seen for the last few months.  But there has been significant positive market psychology around BBRY for the last few months. 

 

Another is Apple...but the liquidity is much higher, while product trends do not look as good right now.  But the stock has been so battered (unlike BBRY), that any positive news will send the stock moving higher.  The risk here with both becomes the time arbitrage.  The next quarter might not be the one to create the short squeeze...it may take one or two more quarters, so you have to evaluate the timing risk.  Understand that while fundamental analysis goes into the stock (Apple is cheap, BBRY sales are improving), a significant amount of speculation is occurring here because of the time arbitrage.  You may have to even stagger your bets on a couple of maturities, or look for options that seem mispriced relative to risk/reward. 

 

We don't make these bets often, and they are usually on businesses we understand really well.  It is very likely that we won't attempt on either of these stocks, or on any other stock for several months.  Only when the pitch looks relatively fat, our assessment seems more likely, and the upside is huge, would we consider swinging because of the timing risk.  Cheers!

[kmukul]

Great work Sanjeev. I admired your options analysis on both the BoA and this stock. You have to have the detailed knowledge of the company and understanding of the industry to be ready to pounce.

 

Let me guess one of your next option plays. BBRY has the same large short interest and upside potential, probably on the next earnings report (although I lack the depth of knowledge you demonstrate your comments for Dell and Overstock that there is scope for plenty of earnings for a smaller player in a niche seem to apply here as well). If so, how would your strategy work in terms of the choice of the option strike price and expiry date and time of purchase?

 

Yes, that is the type of company that it could work for.  I don't follow BBRY as closely, but understanding what their sales trends have been over the last few months, and the progress of their products would be useful.  I suspect this earnings report will surprise, but once the Q10 comes out, I think that will do even better.  There is a hard-core group of Blackberry users waiting for the physical keyboard phone.  There is no other real product out there like that, as everyone is moving to the touch keyboard.  So Blackberry could enjoy a significant short squeeze, not unlike the one we've seen for the last few months.  But there has been significant positive market psychology around BBRY for the last few months. 

 

Another is Apple...but the liquidity is much higher, while product trends do not look as good right now.  But the stock has been so battered (unlike BBRY), that any positive news will send the stock moving higher.  The risk here with both becomes the time arbitrage.  The next quarter might not be the one to create the short squeeze...it may take one or two more quarters, so you have to evaluate the timing risk.  Understand that while fundamental analysis goes into the stock (Apple is cheap, BBRY sales are improving), a significant amount of speculation is occurring here because of the time arbitrage.  You may have to even stagger your bets on a couple of maturities, or look for options that seem mispriced relative to risk/reward. 

 

We don't make these bets often, and they are usually on businesses we understand really well.  It is very likely that we won't attempt on either of these stocks, or on any other stock for several months.  Only when the pitch looks relatively fat, our assessment seems more likely, and the upside is huge, would we consider swinging because of the timing risk.  Cheers!

 

I think both appl and bbry wont give you kind of returns on overstock, as they dont have so much short interest, doesnt mean they wont give you any returns, For bbry i am not sure if i am looking at the right place (nasdaq.com) as they might have shorts on Canadian exchanges also. I guess we will have to find more ideas.

[twacowfca]

Sanjeev,

 

I was wondering if you could elucidate your approach to these options. I'm fascinated with options and have tentatively been trying out different strategies as I learn about them over the past 3 years. My two favorites are to go long deep, LEAP call options to get get a delta of 1 to the common stock with less money down or to buy way out of the money calls/puts in a binary outcome type situation. That being said, I have yet to ever make any significant returns using options and have typically ended flat or at a loss. I'm curious to know why you picked the options over common and what your thought process was on the risk/reward of the situation.

 

Thanks for any insight

 

I can't speak for Sanjeev, but there is a general answer to your question.  Buying options is usually a losing game like playing the horses. The transaction costs, especially the difference between the bid and the ask, will attrit your capital if you don't have a big edge. 

 

Playing the earnings release game with short term options is a crowded field.  You will lose big time if you don't have insights.  One way to get an edge  is to understand a company extremely well, especially a company that doesn't give guidance and isn't followed by a flock of analysts.  Then, only trade on those rare occasions when you know something big will happen and Mr. Market doesn't.  How do you know what Mr. Market is thinking?  Again, that comes from studying not just the company, but Mr. Market's perception of that  company over time. 

 

Another way to make money with options is to understand what drives the profitability of a company over time and rarely, when there is a row of green lights ahead that Mr. Market can't see, buy leaps if they are attractively priced.  Leaps are typically more likely to be dramatically mispriced than short term options.

 

 

There is another reason to be very selective when buying options: it's a negative sum game for the buyers and a positive sum game for the sellers.  Why is this so?  The sellers make money on average because they are selling volatility, and volatility always regresses to the mean until there is an end of the world event, something that kills the whole system.  Therefore, in a functional system, the buyers of options lose money on average for every trade in addition to the frictional or transactional costs.

 

Therefore, option buyers, like parimutuel bettors on a horse race that have to overcome the rakeoff on every race, must be very selective and only bet when they have an objective and substantial edge over Mr. Market.

[Straddle]

Next time you can better sell half your position and keep the other half in your account. Those options can still be sold later on and you'll reduce the risk by half.

[Cardboard]

I don't think that there was any smarter strategy than what Sanjeev has done or to sell these very short term options after a huge boost right after the earnings release. The stock went up 40%! You rarely see if ever a follow through the next day or this time up by almost 20%. It usually drifts down for days following such up day or until more buyers come in to revalue the story.

 

Just ask yourself, what is the stock going to do on Monday? If you can't answer that question, then there was no way to predict what could possibly have happened on Friday.

 

Congratulations Sanjeev!

 

Cardboard

[Parsad]

Next time you can better sell half your position and keep the other half in your account. Those options can still be sold later on and you'll reduce the risk by half.

 

That's actually what I did.  I had price targets for the other half, but they hit them all in the same day.  They just kept going up $1.95, $2.20, $2.50, $2.80, $3.10 and $3.30.  I kept selling bits of the remaining half after the initial $1.95 sale.  By the end of the day I had hit my price targets and was out.  I just had no idea that it would go up another $3 the next day.  ;D  Cheers!

[Shawn]

Wow congrats, good move lol

[biaggio]

Next time you can better sell half your position and keep the other half in your account. Those options can still be sold later on and you'll reduce the risk by half.

 

That's actually what I did.  I had price targets for the other half, but they hit them all in the same day.  They just kept going up $1.95, $2.20, $2.50, $2.80, $3.10 and $3.30.  I kept selling bits of the remaining half after the initial $1.95 sale.  By the end of the day I had hit my price targets and was out.  I just had no idea that it would go up another $3 the next day.  ;D  Cheers!

 

Nobody ever went broke taking a profit. Who would have thought it would have gone up another $3. How often does that happen? You better forget about it because next time instead of going up more it could go down for a round tripper. I am an expert at this (the round trip to no profit).

 

[petey2720]

Sanjeev, first of all nice friekin trade.  Congrats!!!!

 

I struggle with this same issue as well.  I am an all or none kind of guy.  However, I am starting to consider the advice of Straddle from the previous page wherein he advises to sell half the position, lock-in a significant gain and reduce your risk in half while still enjoying some upside.  Certainly is worth considering going forward. 

[RichardGibbons]

There is another reason to be very selective when buying options: it's a negative sum game for the buyers and a positive sum game for the sellers.  Why is this so?  The sellers make money on average because they are selling volatility, and volatility always regresses to the mean until there is an end of the world event, something that kills the whole system.  Therefore, in a functional system, the buyers of options lose money on average for every trade in addition to the frictional or transactional costs.

 

Based on this, how about on a $50 stock, you sell me $50 leap calls for a penny, and $50 leap puts for a penny.  I'll be willing to play this game indefinitely as long as the stock continues to trade, just so that you don't have to worry about me getting lucky and winning the first time, and not having another shot at it.

 

In reality, the long term profit is determined by the future volatility.  If you're always selling options at implied volatilities that end up being higher than their actual volatility, you'll win.  If the implied volatility turns out to be less than the real volatility, you'll lose. 

 

That's why you're unwilling to sell me those options for a penny -- the implied volatility of the options I'm hoping you'll sell me is too low for them to be profitable to you over the long term.

 

[twacowfca]

There is another reason to be very selective when buying options: it's a negative sum game for the buyers and a positive sum game for the sellers.  Why is this so?  The sellers make money on average because they are selling volatility, and volatility always regresses to the mean until there is an end of the world event, something that kills the whole system.  Therefore, in a functional system, the buyers of options lose money on average for every trade in addition to the frictional or transactional costs.

 

Based on this, how about on a $50 stock, you sell me $50 leap calls for a penny, and $50 leap puts for a penny.  I'll be willing to play this game indefinitely as long as the stock continues to trade, just so that you don't have to worry about me getting lucky and winning the first time, and not having another shot at it.

 

In reality, the long term profit is determined by the future volatility.  If you're always selling options at implied volatilities that end up being higher than their actual volatility, you'll win.  If the implied volatility turns out to be less than the real volatility, you'll lose. 

 

That's why you're unwilling to sell me those options for a penny -- the implied volatility of the options I'm hoping you'll sell me is too low for them to be profitable to you over the long term. 

 

Sorry, my explanation was wrong and incomplete.  There is another important element in particular : time decay, not to mention interest rate, that means that steady sellers of options typically make some money even when the implied vol isn't necessary higher than the historical vol. 

 

What I had meant to say is that option sellers take on the volatility risk in exchange for a fee.  In a more or less  normal distribution, the price of the underlying will be (on average) average, regardless of its volatility in the meantime.  In the long run, the changes in volatility will tend to cancel out (revert to the mean), and the system as a whole, composed of the sellers of options, will make money at the expense of the buyers of options just as the sellers of fire insurance (who provide an important service) will make money off the buyers.

 

However, very selective buyers of options can sometimes make money, especially when implied vol is lower than historical vol because the distribution of stock prices isn't truly normal but subject to sudden changes, especially on the downside.  Also, buyers of leaps (and sometimes short term calls)  can make huge profits if they can predict correctly that a stock price will rise at more than a trivial rate. 

 

However, like gamblers in a casino who don't have an edge on average. Option buyers in aggregate lose money on making these predictions (as the sellers make money), and for the whole group, buying options is a negative sum game.  :)

[RichardGibbons]

What evidence do you have for that, twacowfca?  That doesn't match my understanding, and can't really understand why that would be the case. 

 

e.g. my penny argument proves that there is a price where selling options is unprofitable, and everyone agrees that there is a price where selling options is profitable, and I don't think it's hard to show that there exists a price at which it is neither profitable nor unprofitable to sell options.  Why would one expect option prices to diverge from that price?

 

I've read a few books on options and played around with them for 20 years, but haven't really done them seriously.  So if you have some actual evidence for that, it would be interesting to me.

[twacowfca]

What evidence do you have for that, twacowfca?  That doesn't match my understanding, and can't really understand why that would be the case. 

 

e.g. my penny argument proves that there is a price where selling options is unprofitable, and everyone agrees that there is a price where selling options is profitable, and I don't think it's hard to show that there exists a price at which it is neither profitable nor unprofitable to sell options.  Why would one expect option prices to diverge from that price?

 

I've read a few books on options and played around with them for 20 years, but haven't really done them seriously.  So if you have some actual evidence for that, it would be interesting to me.

 

 

I'm sorry. You're talking apples ( a hypothetically extremely mispriced option) and I'm talking oranges (the aggregate market for buyers and sellers of options) 

 

Best wishes.

[boilermaker75]

What evidence do you have for that, twacowfca?  That doesn't match my understanding, and can't really understand why that would be the case. 

 

e.g. my penny argument proves that there is a price where selling options is unprofitable, and everyone agrees that there is a price where selling options is profitable, and I don't think it's hard to show that there exists a price at which it is neither profitable nor unprofitable to sell options.  Why would one expect option prices to diverge from that price?

 

I've read a few books on options and played around with them for 20 years, but haven't really done them seriously.  So if you have some actual evidence for that, it would be interesting to me.

 

No matter what the price of the option, it is not unprofitable if the position you are assigned is trading below intrinsic value.  Then it is no different than buying the stock. I write many option contracts each month. For April I wrote 164 contracts that I held to expiration. Often all the contracts I write for a given month expire.  April I was assigned a relatively high percentage, 48 total contracts. These were 16 BBT at 30, 10 NOV at 67.50, 19 BAC at 12, 1 AAPL at 410, and 2 AAPL at 425. I have written covered calls on some of these, the equivalent of writing a naked put. But I have a high-confidence level that holding all these positions would be profitable. So even if I made only a penny a contract, I would still be profitable because I used a value investing mindset to determine the stocks I wrote put options. Of course I do pay attention to the amount I am getting for the put option; my cost basis for the stock is lower by the amount of the premium.

[RichardGibbons]

I'm sorry. You're talking apples ( a hypothetically extremely mispriced option) and I'm talking oranges (the aggregate market for buyers and sellers of options) 

 

It's not apples and oranges.  That said, if you don't have evidence for that belief, but just believe it to be true, it's fine to say so.  I was asking because I was curious.  I see lots of covered call sellers saying so, but haven't seen evidence, and when I reason it out, it seems to not make sense.

 

Boilermaker, I share your belief.  The interesting question to me when thinking about it that way is whether it's more economic to sell the naked put, buy a call, or own the stock.  Part of the challenge for me is that the more undervalued the stock, the more safety in selling the put, but also the more upside you miss out on if that put is never exercised and the stock quickly returns to fair value.  In that case, the shares or long calls would be much more profitable.  (e.g. most people were buying BAC calls or shares a year ago, and not selling calls).

[boilermaker75]

 

 

Boilermaker, I share your belief.  The interesting question to me when thinking about it that way is whether it's more economic to sell the naked put, buy a call, or own the stock.  Part of the challenge for me is that the more undervalued the stock, the more safety in selling the put, but also the more upside you miss out on if that put is never exercised and the stock quickly returns to fair value.  In that case, the shares or long calls would be much more profitable.  (e.g. most people were buying BAC calls or shares a year ago, and not selling calls).

 

Richard,

 

Yes the downside of selling naked puts to enter a position you want to hold is not getting assigned and missing the upside. Maybe I have just been lucky, but that really only happened to me once with MCD where I was trying to get it around 50. There are some that never got to my entry price and took off. But I walked away with some put premiums and would have had nothing waiting for my entry price.

 

Boiler