Dr. Joe,
Thanks you for your efforts, on this paper trade, and overall.
Tony Seiter
----- Original Message -----
From: "joe & leigh" <gass20@aol.com>
To: <ConservativeOptionStrategies@yahoogroups.com>
Sent: Sunday, May 16, 2010 8:42 PM
Subject: [ConservativeOptionStrategies] Re: DLS-PAPER TRADE #1
> One correction: there is 97 days to expiration not 100 days. not a big
> difference in the calculations.
>
> Second, we need to factor theta in our return calculations. The
> profit/loss table from poweropt does factor it in. It shows a profit of
> $2769 at expiration for no change in IWM. That is with $25,696 of the
> leaps. Poweropt takes the premiums received and subtracts the theta decay
> of the leap to determine profit or loss. They use the Black-Scholes
> pricing to calculate the value of the leap at the various prices.
>
> They calculate that if there is no change in IWM at short call expiration,
> ie $69.56 the profit would be $2769
>
> The return would be 2769/25696 or 10.78% or 40.6% annualized.
>
> You hear even the professional traders and website gurus that diagonal
> spreads are dangerous if the stock shoots up in price beyond the short
> call strike. Is that really true if you set up the position the way I do?
> Let's see
>
> If IWM increases 15% from $69.56 to $80.00, per table from poweropt our
> position gains $3922 and that factors in theta loss of our leaps. Well
> 3922/25696 is 15.26% even greater than the 15% rise in IWM. This is
> because we received $3825 in short call premiums and the theta decay was
> not near that amount and our uncovered leaps appreciated in value.
>
> Even with a rise of IWM to $100 or a 43.8% increase (highly unlikely) our
> positions profit will be $6789 or 26.4%.
>
> Poweropts calculations (and i have a spreadsheet that closely approximates
> poweropts) assumes the same implied volatility at expiration. These would
> change the returns but not significantly because only the time value of
> the leaps are effected. With our DITM leaps there is little time value.
>
> POINT: there is NO upside risk as many websites claim in the way I setup
> up our dls positions.PROFIT/LOSS AT SHORT CALL EXPIRATION 8/21/2010
>
> The first table is our position of 9:11 sc:leap contracts
> The second table demonstrates that even with 11:11 ratio position at
> expiration
> or even if assigned early will not lose money. That is because our
> difference
> in strike prices of leap and short call is greater than our net debit.
> This
> table is from poweropt website.
>
> This is our position selling 9:11 contract ratio
>
> Price Profit/Loss
>
> $30.00 ($21,024)
> $40.00 ($18,241)
> $50.00 ($12,994)
> $60.00 ($5,635)
> $69.56 $2,769
> $70.00 $3,176
> $80.00 $3,922
> $90.00 $5,196
> $100.00 $6,789
>
> Notice how with this ratio we will participate in some of the capital
> gains of
> IWM, even if IWM goes to $1000.00.
>
>
> This is if we did 11:11 contract ratio
>
> Price Profit/Loss
>
> $30.00 ($20,174)
> $40.00 ($17,391)
> $50.00 ($12,144)
> $60.00 ($4,785)
> $69.56 $3,619
> $70.00 $4,026
> $80.00 $2,772
> $90.00 $2,046
> $100.00 $1,639
>
> Notice how with a 11:11 ratio the p/l decreases but will never go below
> zero.
> It will never go below the difference between strikes minus net debit
> times 1100
> shares or (20-19.88)*1100 or $132.
>
>
>
>
>
>
>
> --- In ConservativeOptionStrategies@yahoogroups.com, "joe & leigh"
> <gass20@...> wrote:
>>
>> DLS-PAPER TRADE #4
>>
>> CONTINUATION
>>
>> Our Initial Position:
>>
>> Starting Cash = $200,000
>>
>> 11 Jan12-50 strike leap @($25,696)
>> 9 Aug10-70 strike short calls @$3,825
>> Cost basis per leap share @($19.88)
>> DLS cash account = $174,304
>> $52,912 for rolling out leaps
>> $122,012 for additional leap purchases when needed
>> DSP = 14.9% (3,825/25,696)
>>
>> Additional points,
>>
>> 1) a 10% correction would have a loss of $20,000 (10%*$200,000) on
>> buy-hold
>> 2) same 10% would decrease our leap $5.84 (see above for explanation).
>> That $5.84 times 1100 shares is $6,424. That is a 3.2% loss of portfolio
>> (6,424/200,000)
>> 3) that does not factor in the $3,825 in sc premiums collected.
>> factoring in those premiums the portfolio loss would only be 1.3%.
>>
>> Regarding leap time value:
>>
>> 1) time value is (50+23.36)-69.56 = $3.80 for 615 dte or 2.26% per year.
>> 2) time value is 1100 times $3.80 or $4,180
>> 3) initial short call premiums collected is $3,825
>> 4) therefore, in first month we have almost entirely paid for all the
>> time value, only $355 not covered.
>>
>> I opened this position as a paper trade in my poweropt. I will keep
>> track of it there and tomorrow I will post profit/loss from poweropt over
>> a range of IWM values at the short call expiration 8/21/2010.
>>
>> For now, please read, ask questions.
>>
>> When we need to make adjustments, I would like members to post how they
>> would manage the position. I generally do not make any adjustments until
>> Wednesday before short call expiration if it is ITM. If OTM, I follow
>> closely and if it goes ITM on Thursday or Friday I make adjustments. I
>> avoid assignment at any cost.
>>
>> I WILL CONTINUE WHEN NEXT 11 CONTRACTS TO BE ADDED AT JUNE EXPIRATION.
>> However, I will entertain questions/suggestions at anytime.
>>
>> drjoe
>>
>>
>> --- In ConservativeOptionStrategies@yahoogroups.com, "joe & leigh"
>> <gass20@> wrote:
>> >
>> > DLS-PAPER TRADE #3
>> >
>> > At risk is the value of the leap = $25,696 out of $200,000 or 12.85%
>> > rather than 100% if we bought IWM in the buy-hold portfolio
>> >
>> > We have $174,304 to put into the dls cash account. The purpose of the
>> > dls cash account is two-fold
>> >
>> > 1) to roll out our leaps at the proper time when new further out leaps
>> > are available
>> > 2) to purchase additional leap contracts when our minimum monthly
>> > income goal can not be met
>> >
>> > I allocate 30% of that cash for rolling and 70% for purchasing
>> > additional leap contracts
>> >
>> > ie.
>> >
>> > rolling = 30% * $174,304 = $52,912
>> > additional leap contracts = 70% * $174,304 = $122,012
>> >
>> > Now we need to generate our monthly income by selling short calls.
>> >
>> > What strike price for the short call?
>> >
>> > I select the strike with the most time value.
>> >
>> > What expiration for the short call? (revision of my original DLS
>> > Paper)
>> >
>> > I go out to a 3 month expiration.
>> >
>> > Let's look at the reasons for my revision. I have had people who
>> > initiated a dls strategy purchasing all desired leap contracts and sell
>> > near month short calls only to see a market correction. The percentage
>> > loss looks enormous and has scared people into closing the position and
>> > considering it a failure. A 10% drop in IWM would represent about a
>> > 25% drop in the value of our Jan12-50 strike leap.
>> >
>> > Math: IWM at $69.56 with a 10% drop would be a $6.96 drop in value.
>> > Our Jan12-50 strike leap at $23.36 with a delta of 0.84 would drop
>> > about $6.96 * 0.84 = $5.84
>> > Therefore, our leap would drop from $23.36 to ($23.36-$5.84) $17.52 or
>> > a 25% loss of market value.
>> >
>> > If there is a correction, by going out to a 3 month expiration for our
>> > short calls and legging into full leap position over 3 months we
>> > purchase additional leaps at a progressively lower premium thereby
>> > dollar cost averaging into the position.
>> >
>> > Another reason is the premiums of the short calls at 3 month expiration
>> > are much greater and affords us greater downside protection, often
>> > greater than 12%.
>> >
>> > Another reason is that more often than not the premiums at 3 months
>> > will make the difference between our short call and leap strikes
>> > greater than our net debit (leap cost - short call income). This is
>> > important because even if we sell short call contracts equal to number
>> > of leap contracts we are guaranteed a profit. Even if assigned early
>> > or at expiration.
>> >
>> > How many short call contracts to sell?
>> >
>> > Based on above for the initial positions one could sell at a ratio of
>> > 10:10 and have more downside protection, often greater than 15%.
>> >
>> > However, I will sell at a ratio equal to the delta of the leap.
>> > ie....8:10, leap delta is 0.84 so I roll down to 0.80.
>> >
>> > That allows us to participate in an uptrend of the underlying while
>> > still giving us our monthly income goal.
>> >
>> > So, let's look at our initial short call position.
>> >
>> > 11 leap contracts * 0.84 is 9.24 rolling down to 9 short call contracts
>> > Aug10-70 strike call is $4.25 (100 dte)
>> > Income generated is $4.25 * 900 = $3,825
>> >
>> > Has our income goal been met? Remember this is 100 days to expiration
>> > so we need to adjust that $3,825 to see if it meets our monthly goal of
>> > $3,333. We can do this by taking the $3,825 * 90 days (3 months)/ 100
>> > days to expiration = $3442.
>> >
>> > Our monthly goal is met.
>> >
>> > Before we move on let's look at our net debit (cost basis):
>> >
>> > Leap cost = ($25,696)
>> > Short call premium = $3,825
>> > Net debit = ($21,871)
>> > Cost basis per leap contract = ($21,871/1100) = ($19.88)
>> >
>> > Remember, the difference in out strikes is $70 minus $50 or $20
>> > That $20 is less than our net debit of $19.88. Therefore, even if
>> > assigned and even if we sold ratio of short call to leap of 11:11. We
>> > will not lose money.
>> >
>> >
>> >
>> >
>> >
>> >
>> > --- In ConservativeOptionStrategies@yahoogroups.com, "joe & leigh"
>> > <gass20@> wrote:
>> > >
>> > > DLS-PAPER TRADE #2
>> > >
>> > > CONTINUATION
>> > >
>> > > Our monthly income goal: $40,000 / 12 months is $3,330
>> > >
>> > > What leap expiration? What strike price for the leap?
>> > >
>> > > I go out to the furthest one available. If I was actually opening
>> > > this position i probably would wait until the January 2013 IWM leaps
>> > > become available in the fall, but the furthest out right now is the
>> > > January 2012. Reason? the theta of the leap is minimal and the time
>> > > value per day is smallest.
>> > >
>> > > I pick a strike DITM and one with at least a delta of 0.80. Reason:
>> > > there is very little time value at that delta. A major risk of
>> > > diagonal spreads is changes in implied volatility (vega effect).
>> > > These changes effect only time value therefore we have minimized the
>> > > vega effect in our position. (not totally eliminated it).
>> > >
>> > > Therefore, for our leap position I have chosen the Jan12-50 strike
>> > > trading at $23.36 with a delta of 0.84.
>> > >
>> > > How many leap contracts should we purchase?
>> > >
>> > > In our buy-hold portfolio we had $200,000 to allocate for the
>> > > purchase of IWM. At $69.56 we would have purchased ($200,000/$69.56)
>> > > or 2875 shares. The equivalent stock position using leaps would be
>> > > 2875/delta of 0.84 or 3423 shares or 34 contracts. Since we will be
>> > > legging into the full dls position over 3 months I will use 3300
>> > > shares to make calculations easier. That would be 11 (1100 shares)
>> > > contracts per month for 3 months.
>> > >
>> > > We will purchase 11 contracts now and sell short calls with
>> > > expiration of Aug10.
>> > > At June option expiration we will purchase 11 more leap contracts and
>> > > sell short calls with Sept10 expiration and at July expiration we
>> > > will purchase the remaining 11 leap contracts and sell short calls
>> > > with Oct10 expiration. We will, at July expiration, have our desired
>> > > dls position of 33 contracts.
>> > >
>> > > Initial leap cost = 1100 * $23.36 = $25,696
>> > >
>> > > TO BE CONTINUED
>> > >
>> > >
>> > >
>> > >
>> > > --- In ConservativeOptionStrategies@yahoogroups.com, "joe & leigh"
>> > > <gass20@> wrote:
>> > > >
>> > > > Mike Cleveland posted this recently:
>> > > >
>> > > > "One thing that would really benefit me, and possibly others, would
>> > > > be to "start from scratch." I'm sure you have done this in your
>> > > > paper, but it would be nice to be able to discuss it together to
>> > > > help clarify, for people like me who are new.
>> > > >
>> > > > It would be good to do a "From the Beginning" post. What is a
>> > > > "DLS?" How do you find good trading candidates? Do you do any ETF
>> > > > "DLS" trading? How far out in the future do you look for
>> > > > candidates? What strike prices? How do you enter? When do you
>> > > > adjust?
>> > > >
>> > > > If you just did one post per day, starting with the basics, it
>> > > > would allow us to follow along and ask questions.
>> > > >
>> > > > Would you consider this?"
>> > > >
>> > > > Most of the answers are in my paper. I am modifying the expiration
>> > > > date for the short calls and will revise the paper when i get a
>> > > > chance.
>> > > >
>> > > > I can establish an initial dls position and go through the
>> > > > mechanics. However, once established it is pretty boring. Really
>> > > > nothing to do until expiration of the short calls which i am going
>> > > > to change from a one month sc to a 3 month sc which i will explain
>> > > > shortly.
>> > > >
>> > > > 1) Critical: establish a buy-hold portfolio
>> > > >
>> > > > For simplicity, let's say you have a $500,000 retirement portfolio
>> > > > and you would like to allocate 40% into equities and 60% into fixed
>> > > > income.
>> > > >
>> > > > Equities 40% is $200,000. I trade only diversified ETF's and the
>> > > > one's I use most often are SPY, IWM, EFA and EEM. I believe it is
>> > > > very difficult to be successful trading the dls strategy using less
>> > > > than 10 contracts initially. If your capital only allows 10 to 15
>> > > > contracts trade only one of SPY, IWM or EFA. EEM is too risky,
>> > > > imo, if you can only trade one ETF in the dls strategy. Again for
>> > > > simplicity, let's choose to use all the $200,000 trading IWM in the
>> > > > dls strategy.
>> > > >
>> > > > 2) Next we have to select a % return goal for your $500,000.
>> > > > Remember, each of us have different goals and we will not all
>> > > > select the same goal. For this example, I will select one. Since
>> > > > returns are higher with more risk and lower with lower risk and
>> > > > since dls portfolio strategy has significantly less money at risk
>> > > > than a buy-hold portfolio I am going to select a 10% annual return
>> > > > on our $500,000 or $50,000 per year.
>> > > >
>> > > > A diversified bond ETF is yielding about 4%. If we put our
>> > > > $300,000 fixed income portion in that we should return about
>> > > > $12,000 per year. If we set a 20% return on our dls portion,
>> > > > $200,000 * 20% is $40,000. The $12,000 and $40,000 yields
>> > > > $52,000 which is a 10.4% portfolio return.
>> > > >
>> > > > Summary:
>> > > >
>> > > > Portfolio:
>> > > >
>> > > > $300,000 in a bond ETF (like BND) goal 4% or $12,000
>> > > > $200,000 in IWM using dls strategy goal 20% or $40,000
>> > > > Total return $52,000 or 10.4%
>> > > >
>> > > > TO BE CONTINUED
>> > > >
>> > >
>> >
>>
>
>
>
>
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