Day Trading & Forex Forum

RogerM

If you find that you are wearing out the carpet between your screen and the toilet because that short you've just placed is going up, why not use options to play moves in the indices.

Here is a scenario that I worked out with the help of a talented mentor on 2nd Jan with the S&P at 1116, since when it has gone to 1131 and pulled back a bit.

The aim is to profit on an orderly pullback whilst hedging against an immediate spike up.

First put on a March 2 x1 short synthetic. i.e. Sell March 2 x 1150 calls for 15 and buy 1 x 1100 put for 27. (Red)

Then put on a January 2 x 2 long synthetic. i.e. sell January 2 x 1050 puts for 2.15 and buy 2 x 1150 calls for 2.05. (Blue)

The end result is shown on the payoff diagram below. The Jan options are shown in Blue and the March positions in Red. If the market spikes up above 1150 before the Jan expiry, you gain more or less $ for $ on the Jan long calls as you lose on the March short calls. If the market carries on rising after the Jan expiry then you have a loss situation if the S&P rises above the greater of 1150 or the Jan expiry AND IT KEEPS ON RISING.

Likewise, if the market tanks below 1050 before the Jan expiry (January short put strike), then you start to give back some of the profit accumulated in the March long puts, and probably show a loss below about 1010.

In the event of an orderly decline, which can go below 1050 after the Jan expiry (when the Blue strategy disappears), profit accumulates in the long March puts. And you still only have to worry if the market rises above 1150 before the March expiry, and there should be an opportunity to buy back the short March 1150 calls at less than you sold them for at some stage in the life of the strategy if they worry you because time-value decay is working in your favour.

So if you get the move, there is immediate profit. If it moves against you there is no problem below the higher of the Jan expiry or 1150, and no problem at any level between 1050 and 1150 before the Jan expiry. There is room to move, and sleep comes easily, and you avoid all the angst that you've been putting yourself through if you've stood in front of a rally and it's running you over. Just a thought!

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regards,

Roger(M)

http://www.wehanghere.com

Marc100

Thank you for the interesting post.

I am slightly puzzled by the following sentence:

"First put on a March 2 x1 short synthetic. i.e. Sell March 2 x 1150 calls for 15 and buy 1 x 1100 put for 27."

Is there another name that the above goes by?
I wouldn't naturally call this a short synthetic .
Something like short ratio combo maybe!

I often get confused by the different options terminology used to describe the same position.

Are you using the above terminology as the position benefits from a downward move, mirroring shorting?

Kind regards

Marcus.

anley

Nice thinking and a well thought out trade Roger

That Hoadley software is great isn't it?

RogerM

Marcus - fair point about terminology, and that's why I show the actual constituents of the position to avoid ambiguity. Strictly speaking a short synthetic is a short call and a long put at the same strike price. In practice, I'd rarely use this as the advantages over just shorting the future are small.

If you split the strikes of the short calls and long puts, then it becomes a "split strike synthetic". This gives some space for it to move against you before you start to lose money at expiry.

Given that the aim of a split strike synthetic is to put it on for nothing (i.e. the short call pays for the long puts), you can sell 2 calls for each long put which enables you to write the calls further out to give you even more space before it starts to cost you if you get the direction wrong. This is a "2 x 1 split strike short synthetic". The downside is that if it gets to the strike of the short calls, it will go wrong at 2 x the rate of a simple 1 x 1 split strike short synthetic.

__________________
regards,

Roger(M)

http://www.wehanghere.com

Marc100

"2 x 1 split strike short synthetic"

Thank you kindly for the explanation.

Marcus.

RogerM

Here's an interesting FTSE 100 trade another contributor, who I will not embarrass by naming, put on back on 02 Dec 04. Thought of following him in, but didn't, to my eternal regret.

Started by opening the following on 2nd dec, with FTSE at 4760 :-

Buy 1 x June 4825 call @ 125
Sell 1 x June 5125 Call @ 29.5
Sell 1 x June 4225 put @ 39.5
Sell 1 x January 4875 Call @ 27



The first payoff diagram explains it better than any number of words. The strategy was opened for a debit of 29 (i.e. £290 with the FTSE at £10 per point). There would be a profit if the whole strategy was liquidated at the January expiry provided the FTSE was between 4675 and around 5010, as shown by the thin blue line, which shows the value of all positions as at 21st Jan. Provided the FTSE was below the January strike of 4875, then all the premium taken of 27 ( £270 per contract) would be retained.

The Jan expiry was somewhere around 4800, so the January 4875 call expired worthless, enabling the whole premium of £270 per contract to be retained. After 21st Jan, the short Jan 4875 call was no longer a liability. The next short call is the June 5125, which is covered by an equal number of long June 4825 calls - leaving a bull call spread, with short June Puts at 4225.

The current pay-off diagram with the FTSE at 5040 is very appealing. Current profit of about £1500 per contract, with an immediate downside of just £290, although losses are theoretically unlimited if the ftse falls below the strike of the short puts at 4225 - currently 800 points away. If this is a concern, it can be bought back for about 3.5 (i.e. £35) and in fact would be a good idea, given that it was sold for 39.5, and there is only 3.5 points of time value remaining. Why carry the risk just to squeeze out the last few points? This leaves a maximum possible loss of £325, and a max possible profit of £2440 if the ftse expires above 5125 in June.

Of course it can always be closed out for a profit at anytime before. Or some more calls could be sold above the current level, which would give the potential for a free remaining position if they expire worthless. This is a great example of how to set up and manage a directional trade - well done.

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__________________
regards,

Roger(M)

http://www.wehanghere.com

roguetrader

Very interesting posts, I have always been fascinated by the clever strtegies that options players employ to set up these plays, am I right in assuming that the options discussed on the FTSE will be european style options, ie cannot be exercised until expiry.
Thanx

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It is fatal to enter any war without the will to win it.

RogerM

Yes - the FTSE 100 index options are always European. In fact I believe the American Style FTSE options have been discontinued thru' lack demand.

__________________
regards,

Roger(M)

http://www.wehanghere.com