Hello Traders,
Thought I would continue a discussion on my current option trading positions and strategies. This segment explores the CIS!! Hopefully it makes sense. I'll try to answer any questions. Glory to God, All Praise is Due Him!! Amen!!
Trades #7; 11; 12 Morgan Stanley (MS);
United Airlines (UAL); Yahoo! (YHOO) Purchase
Calls Instead of Stock (CIS); Hedged with Buying a Near-Term Put Butterfly
& Collar by Selling a Near-Term Call
Without question, the CIS option strategy is by far the most
exotic that requires on-going maintenance and adjustments. However, I believe the strategy logic and
purpose is rather straight forward. I
will do my best to explain how I utilize this strategy and the criteria I use
in selecting my CIS candidates.
The CIS strategy is essentially a “stock replacement”
strategy. As I mentioned at the beginning
of my prior blog today, I believe options represent the most efficient means of
utilizing one’s capital due to the leverage and time-frame one can benefit with
a small amount of money. I believe the
CIS strategy takes full advantage of this benefit.
First of all,
to meet the CIS criteria I have to ask myself a few questions: 1) would I like
to own the shares of this company?; 2) are the near-and-longer-term prospects
for the company positive…do they have a great product or service?; 3) do I like
the management team? 4) do they grow their earnings consistently or at least
improving year-over-year?; 5) do they have good growth potential and are they
taking market share?; 6) do they have a strong balance sheet/cash
position? Obviously, these are the same
fundamental questions you would ask yourself if you were willing to commit
buying stock in a company and becoming a shareholder. You want to take the same
approach with the CIS strategy.
Second, I want
to look for companies that trade in a specific price range: Generally $30-$47
per share. I also prefer to have a stock that is trending higher, but has
pulled back recently in price by 1 or 2 percent. I use $30-$47 price range
because it provides easier hedging ability due to single strike options within
the listed option chain. Single strike
options are generally available in this price range. However, once over $50 per
share, most option chains increase by at least $2.50 per strike. This makes it more difficult to hedge your
long call position and would force you to “split-the-strikes” in order to provide
an adequate hedge. The CIS can be done
at >$50 but it’s a bit more difficult to manage.
Third, the
option bid/ask spreads should be no more than 10 cents wide. The narrower the spread, the better the pricing
you can obtain.
Fourth, there
should be sufficient open interest volume in order to have decent liquidity for
trading in and out of the options when it comes time to enter and exit a
position.
Fifth, I need
the stock to have some volatility and price movement. As discussed in my prior blog regarding double calendars, I
explained how volatility in options provide more attractive premium values and
volatility can help in hedging the CIS strategy. I typically look at a 1 year monthly
chart and want to see price movement average approximately $2-$4 per share per
month.
Sixth, I now
want to select a long deep-in-the-money (DITM) call option that has at least 90
days till expiration. I want
to purchase the calls having at least an 80% delta. I do this because I want the calls to
represent or mimic the actual price movement of the underlying stock. The lower the delta, the less impact it has
to move in relationship to the stock price.
The higher the delta, the greater the impact it has to move in relationship to the stock price. The higher the call
delta, the higher the option premium price or cost will be.
At this point you will need to determine how much capital you are
willing to commit. Initially I typically
buy only +3 long contracts with the idea of possibly buying more depending on how the position behaves. I'll describe that below under various scenarios. As previously stated, the capital requirements are much lower with options than stocks... even DITM options. For example, if you were buying stock instead of the options and the stock is currently at $37 per share for 300 shares, the required outlay for the stock purchase would be 300 x $37 = $11,100. Whereas the DITM may only cost $6.50 each x 3 contracts (or 300 shares) = $1,950 for essentially the same movement in stock price. That is powerful and efficient use of leverage and capital.
Seventh, after
you have selected your long calls to buy, you now need to select your near-term
hedge(s) to protect "some" downside risk to your long DITM calls. Notice, that I said "some", not all your risk. To hedge, I
choose a near-term put butterfly with 25-45 days to expiration. Specifically, assume that the stock is
currently trading at $37 per share and I bought +3 April 32 DITM 90-day
calls. I would immediately hedge this
long call position by buying +3/-6/+3 of the February 38/35/32 (27 days till
expiration) put options. Let’s also assume
the net price of the put butterfly is a debit of $0.54 cents per contract. Thus, the total cost of the put butterfly hedge is approximately $150.00. The near-term put butterfly will help hedge your long
call purchase to the 35 short strike of the near-term option. At the same time you can further hedge your
long call position and possibly pay for the entire cost of the put butterfly protection by selling
a near-term call. For example, you may
be able to find a February 39 call that sells for $0.65 cents. By selling -3 calls, or receiving a credit of $195.00 you more than pay for
your put butterfly hedge at $0.54/$150.00!
However, by selling the 3 Feb 39 calls, you have now “collared” the
trade and have limited your upside potential on your long calls. Depending upon how bullish I am on the stock,
I may forego selling calls initially with the hopes of either getting a higher credit
or increasing the strike by a dollar or two to say maybe selling Feb 40 or greater call at a later
date, or perhaps a Mar 41 call. This decision is usually "one from the gut"!
Eighth,
depending how things work out after placing the trade, you manage the trade
accordingly. For example, assume the
price jumps from $37 to $45. Your
long-dated calls will also jump in relation… in fact the delta will probably be
close to 100% under that scenario. Your
Feb put butterfly would be nearly worthless, so you would lose on that end of
it… but so what? You will have a very
substantial profit on your long calls... remember it’s essentially the same as owning
300 shares of stock. What if you sold a
near term short call and collared the trade?
Obviously, you would lose on that as well. You then would have to decide if you want to
close out the position entirely or possibly roll the near-term call to a later
month? It’s your call! It’s a good problem to have if you ask
me. What about the scenario where the
stock price drops to $34 per share or lower then what?
Well, it depends on a number of things… is the stock down for a
firm-specific reason or is it in sympathy to a downgrade made on a
competitor? Is it a macro reason? Or worst case, did something fundamentally go
wrong with the company that changes your outlook? If that’s the case, you need to exit your
entire position. Otherwise, you may see
this as an opportunity to buy more DITM calls, possibly 30-days further out in
time depending on when this “news” hits or share price drop happens. If you
decide to buy more, it may be necessary to close-out of your put butterfly or
keep it depending again on how many days remain till expiration. In either case, you still need to buy another
+3/-6/+3 put fly… in this case at $34 per share you would likely select the
35/32/29 strikes. Keep in mind depending
on the volatility of the shares, the strike width may be only 2 strikes wide if
it is a less volatile stock. The more
volatile the stock, the greater the width of the strikes you would choose as
your put fly hedge. If you had a scenario where
the stock price fell to $35, your near-term put butterfly would be at maximum
profit at expiration and you could then use the proceeds to help finance the
purchase of more DITM calls and start the process all over again.
In the final analysis, I guess I like the CIS strategy because how often have you
purchased a stock and it immediately went against you? Provided the stock does not crater, and even
if it did you are only out the debit you paid for the calls, at least the put
butterfly hedge and short call if collared , will under most conditions be profitable. And if I still like the company, I can simply buy
more DITM calls and try it again!
Below are the current CIS trade set-ups I have on. These are real trades and are for illustrative purposes only.
*MS @~ $31.03 / $31.54 / $30.55 | MS CIS COLLAR WITH BUTTERFLY HEDGE | Open | Dollar Value | 01/24/14 | Current | Net P&L | MS Current Price: | $30.45 | |||||||
12/20/13 | Buy | 3 | Apr 14 | 27 | Call | $4.60 | -$1,380.00 | $3.925 | -$202.50 | Current Avg. IV: | 29.81% | ||||
01/23/14 | Buy | 3 | Apr 14 | 27 | Call | $4.80 | -$1,440.00 | $3.925 | -$262.50 | 1 σ move +/- to Feb expiry: $32.95/ $27.93 | |||||
01/24/14 | Buy | 3 | Apr 14 | 27 | Call | $3.95 | -$1,185.00 | $3.925 | -$7.50 | ||||||
12/20/13 | Sell | -3 | Jan | 32 | Call | $0.47 | $141.00 | 01/17/14 | $1.36 | closed | -$267.00 | ||||
01/17/14 | Sell | -3 | Jan4 | 32 | Call | $1.39 | $417.00 | 01/22/14 | $0.46 | closed | $279.00 | ||||
01/22/14 | Sell | -3 | Feb | 33 | Call | $0.46 | $138.00 | $0.18 | $85.50 | ||||||
12/20/13 | Buy | 3 | Jan | 31 | Put | $0.87 | -$261.00 | 01/07/14 | $0.48 | closed | -$117.00 | ||||
12/20/13 | Sell | -3 | Jan | 29 | Put | $0.27 | $81.00 | expired | $0.00 | $81.00 | |||||
12/20/13 | Sell | -3 | Jan | 29 | Put | $0.27 | $81.00 | 01/07/14 | $0.08 | closed | $57.00 | ||||
12/20/13 | Buy | 3 | Jan | 27 | Put | $0.11 | -$33.00 | expired | $0.00 | -$33.00 | |||||
01/07/14 | Buy | 3 | Feb | 32 | Put | $1.41 | -$423.00 | 01/21/14 | $0.55 | closed | -$258.00 | ||||
01/07/14 | Sell | -3 | Feb | 30 | Put | $0.56 | $168.00 | 01/21/14 | $0.14 | closed | $126.00 | ||||
01/07/14 | Sell | -3 | Feb | 30 | Put | $0.56 | $168.00 | $0.370 | $57.00 | ||||||
01/07/14 | Buy | 3 | Feb | 28 | Put | $0.21 | -$63.00 | $0.085 | -$37.50 | ||||||
01/23/14 | Buy | 6 | Feb | 32 | Put | $1.06 | -$636.00 | $1.96 | $537.00 | ||||||
01/23/14 | Sell | -12 | Feb | 30 | Put | $0.27 | $324.00 | $0.77 | -$600.00 | ||||||
01/23/14 | Buy | 6 | Feb | 28 | Put | $0.07 | -$42.00 | $0.22 | $87.00 | ||||||
01/24/14 | Buy | 3 | Feb | 32 | Put | $1.84 | -$552.00 | $1.96 | $34.50 | ||||||
01/24/14 | Sell | -6 | Feb | 30 | Put | $0.66 | $396.00 | $0.77 | -$66.00 | ||||||
01/24/14 | Buy | 3 | Feb | 26 | Put | $0.02 | -$6.00 | $0.06 | $12.00 | ||||||
*Underlying Open Share Price | |||||||||||||||
29.61% IV @ open | Initial Option Hedge = | -$102.00 | O P&L= | -$495.00 | |||||||||||
TOTAL MS P&L = | -$495.00 | ||||||||||||||
FOR ILLUSTRATION PURPOSES ONLY!!! |
*UAL @~ $37.70 | UAL CIS COLLAR WITH BUTTERFLY HEDGE | Open | Dollar Value | 01/21/14 | Current | Net P&L | UAL Current Price: | $46.13 | |||||||
12/12/13 | Buy | 2 | Mar | 31 | Call | $7.63 | -$1,526.00 | 01/17/14 | $15.85 | closed | $1,644.00 | Current Avg. IV: | 42.96% | ||
12/12/13 | Buy | 2 | Mar | 31 | Call | $7.70 | -$1,540.00 | 01/17/14 | $15.85 | closed | $1,630.00 | 1 σ move +/- to FEB expiry: $51.60/ $40.68 | |||
01/09/14 | Buy | 3 | Jun | 48 | Call | $4.00 | -$1,200.00 | $4.050 | $15.00 | ||||||
01/17/14 | Buy | 3 | Jun | 49 | Call | $4.65 | -$1,395.00 | $3.675 | -$292.50 | ||||||
12/12/13 | Sell | -2 | Jan | 40 | Call | $0.81 | $162.00 | 01/17/14 | $7.19 | closed | -$1,276.00 | ||||
12/12/13 | Sell | -2 | Jan | 40 | Call | $0.89 | $178.00 | 01/17/14 | $6.85 | closed | -$1,192.00 | ||||
12/12/13 | Sell | -1 | Jan | 40 | Call | $0.89 | $89.00 | 01/03/14 | $1.12 | closed | -$23.00 | ||||
01/03/14 | Sell | -1 | Feb | 43 | Call | $1.16 | $116.00 | $3.975 | -$281.50 | ||||||
01/09/14 | Sell | -2 | Mar | 50 | Call | $1.75 | $350.00 | $1.425 | $65.00 | ||||||
01/17/14 | Sell | -2 | Feb | 40 | Call | $7.59 | $1,518.00 | 01/17/14 | $7.25 | closed | $68.00 | ||||
01/17/14 | Sell | -4 | Feb | 50 | Call | $1.30 | $520.00 | $0.695 | $242.00 | ||||||
12/12/13 | Buy | 2 | Jan | 38 | Put | $2.01 | -$402.00 | 01/07/14 | $0.54 | closed | -$294.00 | ||||
12/12/13 | Sell | -2 | Jan | 35 | Put | $0.755 | $151.00 | 01/07/14 | $0.10 | closed | $131.00 | ||||
12/12/13 | Sell | -2 | Jan | 35 | Put | $0.70 | $140.00 | expired | $0.00 | $140.00 | |||||
12/12/13 | Buy | 2 | Jan | 32 | Put | $0.27 | -$54.00 | expired | $0.00 | -$54.00 | |||||
12/12/13 | Buy | 2 | Jan | 38 | Put | $1.89 | -$378.00 | 01/07/14 | $0.54 | closed | -$270.00 | ||||
12/12/13 | Sell | -2 | Jan | 35 | Put | $0.70 | $140.00 | 01/07/14 | $0.10 | closed | $120.00 | ||||
12/12/13 | Sell | -2 | Jan | 35 | Put | $0.70 | $140.00 | expired | $0.00 | $140.00 | |||||
12/12/13 | Buy | 2 | Jan | 32 | Put | $0.26 | -$52.00 | expired | $0.00 | -$52.00 | |||||
01/07/14 | Buy | 4 | Feb | 40 | Put | $2.69 | -$1,076.00 | $0.325 | -$946.00 | ||||||
01/07/14 | Sell | -8 | Feb | 37 | Put | $1.275 | $1,020.00 | $0.120 | $924.00 | ||||||
01/07/14 | Buy | 4 | Feb | 34 | Put | $0.52 | -$208.00 | $0.050 | -$188.00 | ||||||
01/07/14 | Buy | 4 | Feb | 48 | Put | $2.69 | -$1,076.00 | $3.150 | $184.00 | ||||||
01/07/14 | Sell | -8 | Feb | 44 | Put | $1.075 | $860.00 | $1.160 | -$68.00 | ||||||
01/07/14 | Buy | 4 | Feb | 40 | Put | $0.41 | -$164.00 | $0.325 | -$34.00 | ||||||
*Underlying Open Share Price | |||||||||||||||
41.02% IV @ open | Initial Option Hedge = | $1,974.00 | O P&L= | $332.00 | |||||||||||
TOTAL UAL P&L = | $332.00 | ||||||||||||||
FOR ILLUSTRATION PURPOSES ONLY!!! |
*YHOO @~ $35.27 & $39.05 / $37.92 | YHOO CIS COLLAR WITH BUTTERFLY HEDGE | Open | Dollar Value | 01/21/14 | Current | Net P&L | YHOO Current Price: | $37.91 | |||||||
11/20/13 | Buy | 2 | Feb 14 | 30 | Call | $6.05 | -$1,210.00 | 12/18/13 | $9.20 | closed | $630.00 | Current IV: | 41.44% | ||
12/05/13 | Buy | 2 | Mar 14 | 34 | Call | $6.15 | -$1,230.00 | $4.800 | - $270.00 | 1 σ move +/- to FEB expiry: $42.25/ $33.59 | |||||
01/24/14 | Buy | 2 | Apr | 33 | Call | $5.95 | -$1,190.00 | $5.975 | $5.00 | ||||||
11/20/13 | Sell | -2 | Dec | 37 | Call | $0.65 | $130.00 | 12/18/13 | $2.03 | closed | -$276.00 | ||||
12/05/13 | Sell | -2 | Jan | 41 | Call | $0.90 | $180.00 | 01/07/14 | $0.70 | closed | $40.00 | ||||
01/07/14 | Sell | -2 | Feb | 44 | Call | $0.97 | $194.00 | $0.390 | $116.00 | ||||||
11/20/13 | Buy | 2 | Dec | 36 | Put | $1.67 | -$334.00 | expired | $0.00 | -$334.00 | |||||
11/20/13 | Sell | -4 | Dec | 34 | Put | $0.68 | $272.00 | expired | $0.00 | $272.00 | |||||
11/20/13 | Buy | 2 | Dec | 32 | Put | $0.21 | -$42.00 | expired | $0.00 | -$42.00 | |||||
12/05/13 | Buy | 2 | Jan | 40 | Put | $2.24 | -$448.00 | 01/06/14 | $0.75 | closed | -$298.00 | ||||
12/05/13 | Sell | -4 | Jan | 37 | Put | $0.88 | $352.00 | 01/07/14 | $0.02 | closed | $344.00 | ||||
12/05/13 | Buy | 2 | Jan | 34 | Put | $0.29 | -$58.00 | expired | $0.00 | -$58.00 | |||||
01/06/14 | Buy | 2 | Feb | 41 | Put | $2.61 | -$522.00 | $3.750 | $228.00 | ||||||
01/06/14 | Sell | -2 | Feb | 38 | Put | $1.14 | $227.00 | $1.735 | -$120.00 | ||||||
01/06/14 | Sell | -2 | Feb | 38 | Put | $1.14 | $227.00 | 01/24/14 | $1.72 | closed | -$117.00 | ||||
01/06/14 | Buy | 2 | Feb | 35 | Put | $0.39 | -$78.00 | $0.545 | $31.00 | ||||||
01/24/14 | Sell | -4 | Feb | 36 | Put | $0.82 | $328.00 | $0.855 | -$14.00 | ||||||
01/24/14 | Buy | 2 | Feb | 34 | Put | $0.31 | -$62.00 | $0.325 | $3.00 | ||||||
*Underlying Open Long Call Price | |||||||||||||||
32.17% IV @ open 11/20/13 | Initial Option Hedge = | $100.00 | O P&L= | $151.00 |
Remember that option trading is risky business. Become knowledgeable and paper trade before using real capital!! All material in this blog is for illustration purposes only.
Happy Trading & God Bless!
H2Options