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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 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

Collaring a Broad Equity ETF for Stable Returns?

Does a long options collar effectively hedge a broad equity exchange-traded fund (ETF), protecting against the downside while capturing a reasonable upside? In their April 2008 paper entitled “Collaring the Cube: Protection Options for a QQQ ETF Portfolio”, Edward Szado and Hossein Kazemi examine the risk-return characteristics of a passive (mechanical, no market timing) long collar strategy on the Powershares QQQ trust ETF (QQQQ), including transaction costs. A collar consists of a put option position to protect an underlying long equity position, combined with covered call options on the same underlying to fund the puts (thereby limiting upside potential). The authors consider 27 different collar combinations by varying moneyness of the puts and calls (5% out-of-the-money, 2% out-of-the-money and at-the-money) and the initial time to maturity of the puts (one, three and six months). Initial time to maturity for calls is always one month. Using daily closing prices for QQQQ and the selected put and call options over the period March 1999 to March 2008 (108 months), they conclude that: Keep Reading

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