Selling Options on Futures?

April 23rd, 2013, 09:20 PM

kevinkdog

Note 1: All margin numbers are based on OptionsXpress

Note 2: A BIG thanks to Ron99, who gave me a lot of the historical numbers I use below, and for reviewing my initial draft. He is an excellent, selfless teacher of selling deep OTM options.

While this thread many examples of the upside of Option Selling, I think it is critical that people understand the downside and risk involved in selling options, even deep OTM options.

Take my friend Gilbert Goldoptionseller. Last Thursday at the close, he thought it would be a good idea to sell Gold puts. How did he decide this?

For the past year, Gold has been up and down, but seemed to respect so-called support around 1540...

When he looked at the weekly chart, he saw we were still in a long term bull market...

Finally, he looked at the seasonal chart, and found that from April to June, over the last 5 to 15 years Gold was flat to up...

Putting that all together, Gilbert felt he had a pretty compelling argument to Sell Puts. So, he looked for deltas of .02-.04 for the June puts, which had 47 days to go to expiration. He was looking for a monthly ROI of 2-3%...

Gilbert liked the 1300 Put. It had a 2.3% monthly ROI, and was 265 points away from being in the money (that is $26,500 per contract). Gold would have to drop 17% in 47 days for that to happen. Fat chance, thought Gilbert!

So, at the close Thursday, Gilbert sold 5 Puts at $50 each. After commissions, he pocketed $223.65, and using 3x margin as his allocated capital, he had $6,300 allocated to this trade. For each option, he had $840 in excess capital, which would go cover increases in margin and premium.

Of course, Friday the market crashed. Big time. (If you think there is no way Gilbert's timing could be so bad, let me tell you his timing could be that bad. I once Bought Live Cattle near the close on 12/23/2003, an hour or 2 before news report of Mad cow being found in US. Lock limit for days in a row. Not a very Merry Christmas that
year...)

At the close of Friday, Gilbert's Puts were now worth 1.7, with a delta of .033. The options had more than tripled in price in 1 day! Yikes!

Late Friday night, the updated margin requirements came out. Margin had jumped to $978 per option. His new excess looked like this:

Per Option Calculation
Original excess = 840
Increase in premium = -120
Increase in margin = -558

New excess as of Friday night = $162

His excess was almost gone. So over the weekend Gilbert fretted. He yelled at his kids (it was his weekend for visitation), and screamed at his ex-wife. He didn't sleep very well. He drank copious amount of lager, which made him forget about Gold (but also gave him a headache).

Sunday night came, and the Gold crash continued. His 1300 Puts opened at 3.2, almost double what they were on Friday close! Gilbert froze with indecision, although he knew his excess was gone at that point.

He started mumbling to himself, pacing his home office with his hands running thru what was left of the hair on his head.

During the day Monday, his broker raised margin requirements. Between that and the increase in premium on Monday, Gilbert's margin cushion was a distant memory.

But it happened so quick, Gilbert did not have time to think, or to exit. He stayed in on Monday.

Monday close with puts were now worth 30.4. Each. His delta had skyrocketed to .3105. His open loss was now $14,950. His margin requirements are around $6000 - close to the same as outright position margin requirements!

Tuesday, mid day, the 1300 Put price had fallen to 17.70.

***************************************************************

Now, put yourself in Gilbert's shoes. When would you have exited, if at all?

Friday, sometime during the day when option price doubled or tripled
Friday, right at the close, realizing you'd lose $720 total in one quick day. 3 times the amount you intended to make.
Sunday night, when 1300 Put options opened at 3.2, and your margin cushion was gone.
Monday during the day, when things got even crazier
Monday right at close, realizing you'd lose $14,950 total in two days. 67 times the amount you intended to make.

Although this is just an exercise, really try to put yourself in Gilbert's shoes. Please reply, and give your answers and your rationale. I'll give mine a little later.

So kevin what would you have done?

April 23rd, 2013, 09:39 PM

enderqa

ron99-

Can you please clarify your monthly ROI formula for me? The formula you posed earlier was

First of all did you mean

option premium - fees / (IM*.65*2.4) / DTE *30
(option premium - fees) / (IM*.65*2.4) / DTE *30

The first is the one that makes sense to me mathematically.

The second one is correct.

Secondly, is DTE * 30 suppose to have its own parenthesis? Or is the entire equation multiplied by 30.

((option premium - fees) / (IM*.65*2.4) / DTE) *30
(option premium - fees) / (IM*.65*2.4) / (DTE *30)

If you put the formula into excel then you don't need parenthesis for this part.
Both(option premium - fees) / (IM*.65*2.4) / DTE *30
and this ((option premium - fees) / (IM*.65*2.4) / DTE) *30 should give you the same answer.

Third, where did you get the constants you multiply by the initial margin (IM): 0.65 and 2.4? Do they have any meaning?

From the post. For the 0.65. "Assuming flat futures, the margin will average 65% of the IM at 56 days (calculated using SPAN for ES options weekly and EOM)."

The 2.4 comes from using 2X the IM when the position is put on for cash excess and then dropping the 2X to 1X when the option is close to expiration and still far OTM. And then dropping the 1X to zero if still far OTM and very close to expiration. So the excess comes to 1.4 and then you add 1.0 to that for the margin to get 2.4.

Sometimes you may have to keep 2X the entire time. In real volatile times I have gone to 3X. But the 2.4 is an approximate average.

Lastly, the units of the final result: is it in percent (%)? If the equation returns "1.0". Is the result 100% or 1%?
The answer is in decimal. Format your excel cell to be a percentage. So 0.50 shows as 50%.
Thanks in advance.

.

kevinkdog · April 23rd, 2013, 09:57 PM

ron99

So kevin what would you have done?

I would have traded my plan, which is to exit when the margin excess was gone. It would be tempting to exit earlier, but to me that would have been a knee jerk, emotional reaction to a falling market. And those kinds of decisions, in the long run, are almost never optimal.

The problem that this case study shows is one of timing - when exactly does that margin excess disappear, and how often do you check that it disappears?

Most of the time, I think it is probably OK to check every day after close, and exit the next day once you know that excess is really gone. In this case, that would mean you'd exit at Tuesday's open - which is way too late.

So, it is clear to me that I need to plan for this sort of thing, and exit immediately when the cushion is gone. That would have been Sunday night.

Or maybe, my plan needs an "escape clause" for temporarily wacky markets like Gold was on that Friday. Maybe the extreme one day move is enough to say "something odd is going on here. I need to go into survival mode, and get out."

In summary, I think what I would have done, and what I now think I should have done are 2 different things. I'm glad this came up with me as an observer!

April 24th, 2013, 11:57 AM

FYI There is a bid for 0.15 for KCU3 300C 50 times. Very good ROI. Very far OTM. I have put on quite a few.

April 24th, 2013, 01:09 PM

ron99

FYI There is a bid for 0.15 for KCU3 300C 50 times. Very good ROI. Very far OTM. I have put on quite a few.

The days until expiration (DTE) of this option is 107 days, right? Isn't one of your rules-of-thumb to sell options with less than 90 DTE?

April 24th, 2013, 01:19 PM

enderqa

The days until expiration (DTE) of this option is 107 days, right? Isn't one of your rules-of-thumb to sell options with less than 90 DTE?

I wouldn't call that a hard rule. The further OTM you go you have to go more DTE to find any bids. The Jul 300s are at .01 and not worth doing.

So you can look at the Sep 300s as going to .01 in probably <60 days. Which makes the ROI even better for that time frame.

Now if I said to sell Sep 200s, yes, that is too many DTE for that strike.

April 24th, 2013, 01:25 PM

ron99

FYI There is a bid for 0.15 for KCU3 300C 50 times. Very good ROI. Very far OTM. I have put on quite a few.

Dang 7% ROI that is fancy. And I was just wondering what to do with all my freed up margin

This is one of those seasonals that seems to show variance between the 5 year and 15 year. But when you look at the 5 year you realize that 2010 created a 1 year outlier.

kevinkdog · April 24th, 2013, 08:09 PM

I didn't pick up any of those KCU 300 calls Ron mentioned, but I did snag a couple of KCN 200 last week. Of course, as so often happens, I could have gotten 50% more premium had I waited a few days. Oh well...

Here is my current Dashboard of positions. The July NG will be the one I will watch the most.

April 24th, 2013, 08:51 PM

kevinkdog

Here is my current Dashboard of positions. The July NG will be the one I will watch the most.

Do you intend to sell puts around 3.2? Premium is low right now. But when trend reverse down, it might be better sell call. Just my guess.

Edit: Just realized that you meant your current positions.

kevinkdog · April 24th, 2013, 09:15 PM

walker

Do you intend to sell puts around 3.2? Premium is low right now. But when trend reverse down, it might be better sell call. Just my guess.

Edit: Just realized that you meant your current positions.

I agree with you, if the trend does reverse significantly, it would have been better to sell Calls. But right now the trend is up, at least how I see it.

I already did sell these. 3-4% monthly ROI on them.

Here is my thinking beforehand (which I'll be the first to admit may be totally wrong):

1. NG is currently in a 2 month uptrend, although last week has been a leg down.

2. The 5 and 15 year seasonals are flat to up in this time frame.

3. The current uptrend has been pretty steep. Even if it falls at the same rate, by expiration it will still be around 3.6 (this is a weak reason).

I know there has been discussion of selling Calls, but that is just something I don't feel comfortable with right now on NG (I also won't sell ES puts, CL calls, or anything Gold or Silver).

Selling Options on Futures?

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Selling Options on Futures?