Trading Options with the PP

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jimjam21
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Trading Options with the PP

Post by jimjam21 » Tue Jul 26, 2016 2:33 pm

Hey everyone,

Just curious if any of you have used options to manage risk and increase income inside your PP. Since cash is earning 0% right now it looks like selling puts on stocks you wouldn't mind owning could generate a reasonable return of 5-10% per year. That's my first idea, anyone else doing something different?
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Re: Trading Options with the PP

Post by Cortopassi » Tue Aug 02, 2016 10:57 am

Just saw this --

I sold puts and covered calls for a good few years maybe 10 years ago. If you are looking to add something, say like SPY to your PP to rebalance or start it up, seems you could make a little extra by selling a decently in the money put, get the premium from it and then get the stock assigned to you as well. So assuming you were willing to to buy at price "x," you certainly could, for example, sell 1put of SPY at $3.78, get an income of $378, and then get assigned $21,500 worth of SPY (Sept 16 puts).

So that's about 1.7% extra made. Of course, you run the risk that SPY increases and you don't get assigned the shares, so you pocket the $378 but are out the gain you would have had on the stock.

But I'm sure you know all this. My only problem with it, is that I >50% of the time had the underlying move against what I wanted to do. You'd think over time that would have leveled to 50/50, but since I had emotion involved, that was always to my detriment.

There was a time I thought covered calls was the be all end all of investing, and I was doing ok for a while. Until 2008... then of course, everything dropped, and I was too scared to write calls on what I held because if I did get called, the underlying would have been sold at big losses, so I froze and did nothing. In retrospect, I should have added to my positions. But what did emotion do to me back then? I got sick and tired of seeing losses, got scared and sold everything in Jan 2009. Of course Mar 2009 marked the bottom. And then I was terrified of getting back in.

And so on! Until the PP.

For me, not worth the thinking and trading of selling puts or calls. I like the autopilot nature of the PP.
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Re: Trading Options with the PP

Post by iwealth » Tue Aug 02, 2016 2:14 pm

jimjam21 wrote:Hey everyone,

Just curious if any of you have used options to manage risk and increase income inside your PP. Since cash is earning 0% right now it looks like selling puts on stocks you wouldn't mind owning could generate a reasonable return of 5-10% per year. That's my first idea, anyone else doing something different?
I assume you are doing this with money outside of your PP. And I'm also assuming these sold puts are cash secured. You may end up with a bunch of stocks in your possession. Just make sure you have a predefined plan for what you'll do when (not if, because it WILL happen at some point) this happens.
jimjam21
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Re: Trading Options with the PP

Post by jimjam21 » Sat Aug 06, 2016 9:48 pm

Cortopassi wrote: For me, not worth the thinking and trading of selling puts or calls. I like the autopilot nature of the PP.
I hear you, and I'm a complete believer in the PP and don't question its validity or effectiveness. I'm just always looking to improve and maybe get a little more return...I know Harry wouldn't approve, but that's the way I'm wired :D
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Re: Trading Options with the PP

Post by jimjam21 » Sat Aug 06, 2016 10:17 pm

iwealth wrote: I assume you are doing this with money outside of your PP. And I'm also assuming these sold puts are cash secured. You may end up with a bunch of stocks in your possession. Just make sure you have a predefined plan for what you'll do when (not if, because it WILL happen at some point) this happens.
Definitely concerns that I've considered. I could see trading options in the Cash portion of the PP or in a separate VP. For put writing I'm comfortable doing it on the cash I already hold in the PP because of my mindset going into this strategy. Basically, I would only write puts on stocks that I would like to own...I use Buffett's methodology - a company must be super safe and cheap. Worst case scenario I have to buy a stock that I already wanted to own, but if the option expires worthless I just keep the premium. Seems like a win-win, and yes it would all be cash secured.

Here's a quick example...Yesterday (Friday 8/5/16) Eli Lilly (LLY) was down sharply to $81.56, which pushed up the premium you could collect if you sold a put. So I went ahead and sold the 12AUG16 Put at $80 and collected $0.34 per share (100 shares). More thoughts below:

- If the option expires next week I keep the $34 (that's a 0.425% return in a week, or 22% a year if you did the trade every week).
- If the stock falls below $80 I must buy 100 shares and pay $80 per share, no matter how low they get. This may sound risky, but not to me when you consider how good of a business LLY is. That's why you only sell puts on stocks you wouldn't mind owning.
- If you are forced to buy the stock at $80 you could immediately begin selling covered calls to generate income while trying to get out of the stock. I did this a few weeks ago with GILD...

Obviously if you do this on the Cash portion of your PP, you must be willing to hold an allocation of 50% Stock, 25% Gold, 25% Bond - worst case scenario all the puts you sell get exercised and you must buy the stocks. I'm personally willing to take that risk because I know the quality of the companies I would use for the strategy.

All that said, can anyone think of another downside to the strategy that I'm missing, other than the time commitment and a bear market?
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Re: Trading Options with the PP

Post by MachineGhost » Sun Aug 07, 2016 8:05 am

jimjam21 wrote:All that said, can anyone think of another downside to the strategy that I'm missing, other than the time commitment and a bear market?
Lack of cash when you need it to rebalance into gold or bonds?
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes

Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet.  I should not be considered as legally permitted to render such advice!
iwealth
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Re: Trading Options with the PP

Post by iwealth » Sun Aug 07, 2016 10:48 am

jimjam21 wrote:
iwealth wrote: - If you are forced to buy the stock at $80 you could immediately begin selling covered calls to generate income while trying to get out of the stock. I did this a few weeks ago with GILD...

All that said, can anyone think of another downside to the strategy that I'm missing, other than the time commitment and a bear market?
You know what they say, markets take the elevator down and the escalator back up. If things go sour and LLY loses 10% in a week, your $0.34 gain/share becomes a $6-7 loss. Assuming you are lucky and the decline stops there, you won't necessarily be able to get any premium for calls near your buy price. But that's all I have really. Over time the big losses tend to eat up the the small gains leaving you with normal returns (whatever that is).

IMO these strategies are more appealing with a high VIX and high options premiums.
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Re: Trading Options with the PP

Post by buddtholomew » Sun Aug 07, 2016 4:06 pm

Risking 8K in capital to earn $34?
Assuming you pay $3 in transaction costs + an option premium per lot to buy/sell, the gains are capped at less than .3%. Your downside is unlimited after the option is assigned to purchase the shares. Sounds like a very poor tradeoff to me. What am I missing?
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Re: Trading Options with the PP

Post by Kbg » Sun Aug 07, 2016 7:01 pm

.
Last edited by Kbg on Mon Aug 08, 2016 9:01 am, edited 1 time in total.
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Re: Trading Options with the PP

Post by Cortopassi » Mon Aug 08, 2016 8:51 am

buddtholomew wrote:Risking 8K in capital to earn $34?
Assuming you pay $3 in transaction costs + an option premium per lot to buy/sell, the gains are capped at less than .3%. Your downside is unlimited after the option is assigned to purchase the shares. Sounds like a very poor tradeoff to me. What am I missing?
Budd, you are missing nothing. When volatility was higher and premiums were higher, I *thought* it was a good risk, and then got saddled with downward trajectory stocks in 2008 that I couldn't write calls on anymore for fear of getting them called away at a loss.

Writing options, esp. calls, sounds really good on the surface. There are many books and people out there promoting it. As with anything, some people are good at it. I was for a while, until I wasn't.

If I recall correctly, there were a lot of calls I wrote where the premium for 1 month out was in the 2-3% range. Not bad, for holding say, $5k of stock, I could pull in $150/month on it. Looking back, if I was smarter, I should have realized that volatility was going up, and overall that was a very scary thing. Volatility was going up because the market was getting ready to cave.

In the current environment, I would say it's hardly worth the effort.
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Re: Trading Options with the PP

Post by IDrinkBloodLOL » Thu Aug 11, 2016 12:32 pm

What about the value of buying put options for your own stock, bond and gold funds, termed a year out?

It's not uncommon in PP to have one stinker and two productive assets each year, with cash always being roughly flat.

I haven't looked at an option table for years, but do the numbers for buying puts that way add up? PP was more or less fine through the '08 crash, but how would it have turned out if you had a put so that your personal stock holding was essentially flat? Would that use of puts have been cost effective?
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Re: Trading Options with the PP

Post by iwealth » Thu Aug 11, 2016 12:40 pm

IDrinkBloodLOL wrote:What about the value of buying put options for your own stock, bond and gold funds, termed a year out?

It's not uncommon in PP to have one stinker and two productive assets each year, with cash always being roughly flat.

I haven't looked at an option table for years, but do the numbers for buying puts that way add up? PP was more or less fine through the '08 crash, but how would it have turned out if you had a put so that your personal stock holding was essentially flat? Would that use of puts have been cost effective?
That'd be extremely expensive. For example, the Oct '17 expiring SPY 215 PUT (with SPY trading at 218.50) currently costs $14.25. And that's with the VIX at extreme lows.

Even going far out of the money is still going to cost you a couple % of your total account value if you wanted to hedge 100% of your holdings. That's a big drag over time.
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Re: Trading Options with the PP

Post by IDrinkBloodLOL » Thu Aug 11, 2016 12:42 pm

I figured as much. Thanks.
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Re: Trading Options with the PP

Post by Cortopassi » Thu Aug 11, 2016 12:45 pm

Protective puts, or married puts, I toyed with that many times, but never pulled the trigger, because they were too expensive. Of course, if I had them during 08 they would have helped a lot, but then you still run into two main issues:

1) When to sell? You need to make a judgement that the underlying has stopped going down.
2) All the premiums you are losing over time when you can't cash them in at a gain and they expire worthless.

I think they might work for one corner case -- buying an individual stock, say, with the expectation of a great earnings report, or some FDA approval on a drug, and marrying a put to it. If it skyrockets, you've given up some gain by having bought the put, but if it craters you are protected. For like a 1 week-3 month timeframe though. Going out a year the premiums and decay will kill you.
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Re: Trading Options with the PP

Post by Kbg » Fri Aug 12, 2016 4:21 pm

Let's just go with averages...

If you are a buyer of puts over a long period of time you are simply going to decrease your portfolio volatility in exchange for a lower CAGR. Details will be estimable based on your method for executing the above. Now if you actually have the ability to time the markets then doing this could be quite nice for reducing volatility and improving returns...so can you do that?

If you can, just close your position and/or go short and save yourself the insurance premiums.
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