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Equity Options

Can investors/speculators use equity options to boost return through buying and selling leverage (calls), and/or buying and selling insurance (puts)? If so, which strategies work best? These blog entries relate to trading equity options.

A Few Notes on Day Trading Options

In his 2009 book Day Trading Options: Profiting from Price Distortions in Very Brief Time Frames, author Jeff Augen argues that individual investors operate at material informational and analytical disadvantages whether focusing on fundamentals or trend-based technical indicators. He has written this book”for investors who are seeking a different approach and are willing to work very hard to perfect new trading strategies.” This different approach seeks to exploit “well-characterized pricing anomalies and distortions… [that] exist, in part, because contemporary option pricing models assume continuous trading… Today’s option market [responds to market down time] by varying the implied volatility priced into option contracts [thereby presenting a] profit opportunity [that] can become very large under certain circumstances.” Also, “news events often introduce brief distortions that take many minutes for the market to digest. During these brief time frames the market becomes inefficient…[as detected by] a new technical indicator that can be used to quantify rising or falling volatility.” Some notable points from the book are: Keep Reading

A Few Notes on The Options Trading Body of Knowledge

In his 2009 book The Options Trading Body of Knowledge: The Definitive Source for Information About the Options Industry, author Michael Thomsett “provides a market overview and discussion of risks, in addition to a comprehensive listing of strategies.” He states that the “…book is designed for the options trader, whether a novice or skilled pro, who understands and appreciates the market issues.” He states that the book “provides a very comprehensive explanation of how option premium develops based on various elements of value; calculation of returns from options and stock trading; federal taxation works in the options market; how stocks are picked for options trading; online and print resources; and a very complete glossary of terms that options traders will find valuable.” Some notable points about the book are: Keep Reading

Strike Price Rolls for Option Writes?

A reader asked: “If you roll short call (or put) options up or down in strike price as the market moves to stay at-the-money, it seems you can collect quite a bit more time premium during a market trend compared to simply holding the original until expiration. I modify this adjustment process during the last week before options expiration by rolling to the next month when time premium gets below $1. In an range-bound market this process does not work as well as sell and hold, but it provides approximately 40-45% protection (trend capture) in the event of a strong trend down (up). Has anyone looked at this concept in detail?” Keep Reading

Ways to Exploit ex-Dividend Effects?

A reader asked: “I am under the impression that stocks usually drop by the amount of the dividend on the ex-dividend day. Is this true…or more precisely, how true is this? If it is true, couldn’t one just short the stock on that day? If it is not true, could you just hold the stock for that day and reap the dividend? Also, could options be used to make some profits on this? Selling calls or buying puts?” Keep Reading

Wash Rules on Iterative Option Writes?

A reader asked: “I have seen some writings which suggest that iteratively selling puts, or covered calls for that matter, may trigger wash sale rules, even though expiration dates and probably strike prices would vary. The authors mentioned that the IRS may consider the re-establishment of a short position on the same security as triggering the wash sale rule. Are you aware of any definitive rulings on this issue?” Keep Reading

Sell Index Put Options Only When Above Long-term SMA?

A reader asked: “Have you considered a test of selling puts on the Russell 2000 Index only when it is above a long term moving average, such as the 10-month, 200-day, etc?” Keep Reading

Are Some Covered Calls More Profitable Than Others?

On what kind of stocks can covered call writers obtain the best returns? In their July 2009 paper entitled “Cross-Section of Stock Option Returns and Individual Stock Volatility Risk”, Jie Cao and Bing Han investigate how delta-hedged stock option returns vary with volatility risk. They measure this return as the change in value of a self-financing portfolio that is long the call and short the underlying stock, rebalanced daily so that it is not sensitive to stock price movement. They assume trade execution at the mid-point of closing bid and ask quotes. Using returns for about 160,000 at-the-money delta-hedged option positions initially about one and half months from maturity (and held to maturity) for over 5,000 underlying stocks during 1996-2006, they conclude that: Keep Reading

Turn-of-the-Month Effect and Option Strategy Losses

The Strategy Test presently focuses on iteratively selling put options on the Russell 2000 Index with less than one month to expiration to capture the volatility risk premium. The test strategy seeks to exploit the turn-of-the-month (TOTM) effect to enhance this capture. Are there characteristics of index returns from options expiration (OE) to TOTM, during TOTM and from TOTM to OE that might inform options moneyness and position adjustment decisions? Using daily opening and closing levels of the Russell 2000 Index over the period September 1987 through April 2009 (259 complete months), we find that: Keep Reading

Options Detrimental to Individual Investor Health?

Do individual investors who trade equity options do better or worse than those who do not? In their October 2008 paper entitled “Option Trading and Individual Investor Performance”, Rob Bauer, Mathijs Cosemans and Piet Eichholtz examine the impact of option trading on individual investor performance. Using all daily trades and end-of-month portfolio positions for 68,146 individual Dutch investors (41,880 who trade equities only and 26,266 who trade options at least once) over the period January 2000 to March 2006, they conclude that: Keep Reading

Actual Index Options Trading Results

What kinds of returns do options traders actually achieve? In their January 2009 paper entitled “Investor Trading Behavior and Performances: Evidence from Taiwan Stock Index Options”, Bing Han, Yi-Tsung Lee and Yu-Jane Liu examine trading behavior and net returns for all traders of Taiwan stock index options. Using the complete record of transactions, orders and quotes for Taiwan stock index options during 2002-2005 (involving 238,303 individual investors, 1,076 domestic institutions, 50 foreign institutions and 29 market makers), they conclude that: Keep Reading

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