
Basic Option Strategies - karamazov
https://datanitro.com/blog/2012/11/13/Options/
======
ChuckMcM
I liked the intro. There is another use for options, which is insuring against
lost gain. Allow me to share a couple of anecdotes.

In January of '95 I knew my 3rd child was on the way and wanted a 'sedan' type
car to take the family out. (we had my sports car and a mini-van at the time)
I was working at Sun and had been participating in the Employee stock purchase
program forever, and Sun stock had gone up a bit so I sold 1,000 shares at
$37/share which after taxes and fees netted me enough cash to buy a Chrysler
sedan for cash. No loan, no payments, pink slip on the first day I owned it.
That was an _awesome_ feeling. In March of that year Sun announced Java, the
stock ended up doubling and splitting 3 times. The car I paid 'cash' for was
worth 1.6M$ (at the peak of Sun's stock value). Youch!

So my Dad's buddy, a Swiss ex-banker, chastised me for not hedging my bet by
buying an 'out of the money' call option, 12 months out. He explained that if
the stock never went anywhere it would lower the effective 'gain' from my
sale, but if the stock went up a lot it would protect me against having lost
out on that value.

Flash forward to 2006, I'm heading for Google, I've got a chunk of NetApp
stock and I having lived through the dot com crash I want to diversify. So I
sell a lot of my NetApp stock at $35, _and_ buy options for the same amount of
stock a year out at $40. (so 'out of the money' by $5). NetApp kept going up
and up, and I sold the options a month before they were due (NetApp was
trading at $55 and I wanted to keep the gain in the the right tax year) and I
got a nice 'bonus' payout on what was essentially the same stock I had sold
nearly a year earlier.

The option was there only to protect against missing out on a large rise in
the stock price. (which it did, not as well as if I had kept it all but I
didn't miss out completely either).

I found that I would keep stocks longer than I should because I was 'worried'
about whether or not it was the right time to sell. Options allow you to 'buy
insurance' on against that worry, and for me that has made me more willing to
make significant changes in my portfolio over the years.

~~~
karamazov
This is a great example of using options to lower risk. You can also purchase
insurance outright against a stock falling - if you own a stock and buy puts
for it, you'll be protected against the stock falling below the put's strike
(since you can literally sell it for the strike price to the person who wrote
the puts).

This was originally one of the main uses of options, which is why an option's
price is called a premium - it's an insurance premium.

~~~
beagle3
This is true for shares you own outright.

However, if it is stock that is under SEC "rule 144" lockup (which usually
applies for 6 months following an IPO and most M&As), then the legality of
doing that is murky.

It used to be outright illegal. The letter of the law has changed, and now it
is unclear. I was in this situation, and personally couldn't find a single CPA
or lawyer who would say "I believe it's now legal to hedge rule 144 locked
shares". (And as a result, I didn't, and lost lots of money, and almost came
out with a net loss on a x5 exit)

~~~
jrockway
Not always true: even if you own the shares outright, you may be subject to
obscure SEC regulations about what you can do. When I worked at BAC, we
weren't allowed to engage in any speculative transactions in any security.
Covered calls only.

At my current employer, no options transactions are permitted on company
stock, not even covered calls or protective puts. Of course, you can just sell
it and do whatever you want with the proceeds.

------
scrumper
Not a bad intro at all.

That being said, intros to options scare me in the same way a "Beginner's
Guide to Fugu Preparation' would scare me: as a novice, you have no business
mucking around with such dangerous things, but as an initiate, you have no
need of the article.

Still, there is a readership for such things, and the author is clear to point
out the potentially unlimited downside in the intro.

Now, scripting Excel with Python? I'd forgotten about these guys. My interest
is officially re-piqued.

~~~
beagle3
> as a novice, you have no business mucking around with such dangerous things,
> but as an initiate, you have no need of the article.

That reminds me of an ex-girlfriend's "if you don't already know what you did
wrong, I'm sure not going to tell you!"

More seriously, somewhere along the path from novice to initiate, you have a
need for some material, though - be it this article or another.

Also, I'm not implying you do, but I find it funny that many people think
"stocks are a fine investment, but options are dangerous".

The only real difference in risk is leverage, which is always high in options,
and usually low in stocks. But you CAN get high leverage for stock trading,
and you CAN restrict yourself to a small part of your capital thus
"deleveraging" the effect of options on your portfolio. You need to have some
experience, but definitely of the calibre of a Fugu chef, to practice these.

I think the close proper analogy is the stocks are a sharp household knife,
and options are a butcher's knife.

~~~
scrumper
Ex for a reason, I see :)

There's a bit more to it than just leverage. Writing naked options carries
huge potential downside, unlimited in the case of naked calls.

With a stock you're long, or short. Prices go up and down. Four outcomes to
consider. Options are a bit more involved: covered or uncovered? call or put?
long or short? Then you've got the option price _and_ the underlying price to
think about. Until you're comfortable, it's more than most can manage in their
heads.

Since we're doing 'sharp tool' analogies, I'd be more inclined to go with hand
saw and chainsaw. The level of potential harm you can do to yourself in an
instant with a chainsaw is far greater than that you can achieve with a hand
saw - and it's a much bigger difference than that between the efficiency of
using a chainsaw and a hand saw. Yes, it's powerful, but it's
disproportionately hazardous in untrained or careless hands.

~~~
beagle3
I mostly agree with what you wrote, however:

> Writing naked options carries huge potential downside, unlimited in the case
> of naked calls.

The same unlimited potential downside exists when shorting a stock.

But you have to be a pro to get away from the risk & margin checking.
(Unfortunately, it's actually possible to do that, and most pros do). And
until you've escaped from it, the downside is limited to not much more than
what you have put down as margin.

~~~
scrumper
Good point. As you said above, it's the leverage.

------
photon137
Whenever you're talking about vanilla options, _always_ mention the exercise
type - European or American (or Bermudan/whatever). Single-name stocks like
Facebook, Google have exchange-traded options which are American. Index-
options such as those on the S&P500 are usually European.

Also, it's a good intro for buy-and-sit strategies but rarely does anyone sit
on options till expiry. They try to make some gamma-based profits (delta-
hedged option) or some vol-based profits (strangle/straddle etc).

------
BenoitEssiambre
I'm a buy and hold long term investor for whom options seems ill suited.
However sometimes I feel they might be useful to me because I could focus my
investments on my area expertise and hedge against everything else.

As a developer and tech business owner I feel I have an edge when it comes to
picking stocks in the tech sector. However, I'm not very good at predicting
macroeconomic issues. Even though I think my stock picks will do well compared
to larger sectors and markets, I'm always nervous my savings will be decimated
by such things as europe/fiscal cliff/china which I'm not very good at
predicting.

Unfortunately, I'm not sure how to edge against those things. I read on
wikipedia that I could short sell an index or buy put options to protect me
against this macro volatility but I'm not sure how to decide which to do, how
to do it through my online broker, how to pick the parameters, how to decide
if it's worth the premium or if it's worth doing at all given my relatively
small and passive portfolio I use simply for saving for retirement.

Are there resources for simple savers like me who'd like a simple solution to
hedge out a bit of the unknowns out of their portfolio and focus it more on
their area of expertise?

~~~
confluence
You know John Maynard Keynes was once asked the same thing:

 _> Investment board: What happens if the world goes off a cliff?

> John Maynard 'The Badass' Keynes: There will be bigger things to worry about
> if that happens - stocks will be the least of your worries._

If the economy tanks - everything will tank. Your house, your job, industry
production - everything. Trying to protect yourself from the market in this
case is like those people who worry about possessions in a burning house -
possessions mean nothing, just try and get out alive.

You can't hedge the end of the world. You can only prepare to die. Because in
those situations - luck keeps people alive, not money. See all revolutions,
the Holocaust, uprisings and rebellions. Money doesn't save you - property
doesn't exist - titles don't matter - law vanishes into thin air - there are
no rules and who you are means nothing.

If you're a passive investor - suck your shit up - that's your strategy. If
you don't sell you'll be fine. If the world ends you'll be dead.

Currently, I'm long TSLA, and have been long GOOG and AAPL. I've had huge
drawdowns - 10%-20% within a month, and I've had huge gains. My largest draw
down on a position so far has been 60% - that's 60% gone into thin air. And
guess what? I don't give a shit.

You ain't a real investor until you've had a position blow up in your face and
drawn down nearly 100% at least once, and not sold because you knew you were
right. That's the nature of the game. Investors are lonely - they look at the
world and stand there and say: No you're wrong world, so very wrong, and here,
I'll put my life on the line to prove you wrong.

I'm a value investor and I'm in here for the long haul. I play vol sometimes,
huge drops below margin of safety I go all in, huge rises above, I'll just
exit. But I'm always net long.

Everyone is always net long.

~~~
BenoitEssiambre
I get what you're saying. And you're probably right, my passive strategy is
probably ok as it is. However, in 2007 the US stock market dropped by about
50% and stocks were indeed a worry while my employment remained relatively
stable.

I sorta worry about a sovereign default cascade in europe with similar effects
on stocks as the financial crisis of 2007. I'm not sure if trying to hedge for
this is worth the premium though.

~~~
confluence
I always chortle when people say stocks fell 50%. If a house is selling for a
trillion dollars, and it falls back to a million, would you be surprised? No.

Well then, if the market is overpriced by 100% and it falls 50% - why would
you be surprised or worried. If the market continued to crash - you would be
unemployed - as domestic consumption cycled down. We'd either end up like the
Japanese or the Germans - either way - we'd all be fucked.

------
OldSchool
This is a good intro to something everyone analytical should know something
about.

It's also worth knowing that overall, most options expire worthless, so
apparently selling them is a better game than buying them. Also spreads are
typically pretty large so trading them profitably requires big moves.

The built-in 'cost' of options and futures is of course 'time decay' as they
are all dated and you pay more for a date further in the future.

I think they'd be very useful if you found yourself in a position with a large
amount of restricted publicly-traded stock. I'd imagine you couldn't legally
just lock in your equity by going short in a retail account but markets are so
highly-correlated now that you probably wouldn't even need options on your
particular stock to afford yourself some protection against many downside
situations. Rather you might just own puts on the closest-related index. It
won't be free of course but if you spent 5% of your position as "insurance"
until you could sell it could prove to be worth it versus weathering a loss
due to overall supply/demand forces that could take the sector and market down
50% or more without any substantial change in your own company's numbers.

~~~
confluence
Mark Cuban did this back when he sold Broadcast.com - see here:
[https://www.quora.com/How-did-Mark-Cuban-survive-the-dot-
com...](https://www.quora.com/How-did-Mark-Cuban-survive-the-dot-com-crash)

------
kghose
The more I read about the stock market the more it resembles a complex
gambling scheme to me. My view of the stock-market limited to high-school
economics is the straightforward "here's how you own part of a company and how
you can support a company you want", and for companies "if you do good work,
people will give you more money to expand and innovate" and I think at the
base level that is there, but there is this whole side-show with the gambling
that now totally shadows the original intent.

~~~
marvin
Well, more abstractly, anything you ever do is a gamble. Getting higher
education? You're gambling that it'll pay off better than just working in a
job that doesn't require a degree. Putting your savings in a bank account?
You're gambling that the interest rate will be higher than inflation and also
higher than the risk-adjusted returns in any other investment type. Buying a
house instead of renting? You're gambling that it'll be cheaper and more
convenient than renting, after capital costs and price changes. Renting
instead of buying? The opposite. Any choice you make, including not making any
choice, has consequences.

Putting your money in the stock market? You're gambling that the risk-adjusted
returns from the stock market is higher than that of a bank account.
Performing stock or option trading according to some strategy? You're betting
that you're smarter than your counterparties. Trading any type of paper you
don't understand? That's more akin to playing the lotto.

It's a continuum.

~~~
pm90
Can I just say that this is an incredibly good comment?

Seriously, between the finite time that one has to live and the decisions you
have to make everyday, I think any notion of "satbility" is at best, an
illusion. Only change is constant.

~~~
marvin
Thank you :)

------
confluence
Basic option strategies: the TLDR; guide:

If you are buying options - you will consistently lose money. Both time and
risk premia overpricing go against you. If you don't make the mark within the
time period (and market dynamics are notoriously hard to predict) - you will
lose 100%. Breaking even often requires a large 5-7% move in your favour - and
that just doesn't happen often enough - especially in the one month buy-to-
mark time frame that most options trade at. Nassim Taleb does this - he
probably makes more money selling pretty books and giving fancy talks.

If you are selling options - you will consistently make fat stacks until you
blow up (since you're the counterparty of the above buyers). You can push
naked index puts or calls all you want, and make an absolute fucking killing.
I'm not kidding. You could easily pull $10-200K a month in profit, depending
on how much of a baller you think you are, and how much capital you have
backing your risk-taking ass (talking individual traders here).

But this money isn't without insane risks, have no doubt - you are playing
with an armed thermonuclear warhead. If all the market correlations go to one
and you're the last guy holding the bag containing other people's vol - you
will get decimated. LTCM did this for 3 years - blew up year 4 - lost $5
billion in one month. LTCM principals went on and started a bunch of similar
firms - finance is apparently very forgiving of failure - it shouldn't be.
Most of those funds went thermonuclear back during the 2007 GFC.

If you do a mixed strategy - you'll end up with mixed results - because you're
just mixing the above. No option strategy outside of market making
consistently makes money (computational traders making markets and taking
hedged spreads).

It's exactly like insurance. Insurance buyers pay up, but they never want to
actually use it (unless they are committing fraud/market manipulation), and
are happy to burn that cash to protect themselves. Insurance sellers are happy
to sell, but their industry is commodity, and the only way they make money is
by investing the float they have on hand between cash inflows (buyer premiums
today) and cash outflows (buyers claiming a year later).

Problem is shares aren't like physical goods - they aren't bound by physical
laws and hence do not follow the normal distribution. Share prices can go to
infinity and hit zero all over the course of a day - their just bits of data
in a db somewhere in Jersey. Car crashes, geographically separated houses and
diversified mega-cat risk don't do that - often :D.

If you put in a costless collar on a stock you already own, you cap both your
upside and your downside relatively cheaply (this is how Mark Cuban survived
the dot-com crash with $2 billion in Yahoo! stock).

Outside of those few lessons - unless you are pushing statistical liquidity or
selling millions of options per day - stay the fuck away from them. Individual
investors should either go passive index or if they know an industry inside
and out value-growth.

Everybody else should either be supply liquidity (HFT - not too profitable
anymore) or pushing relative stat arb (RenTech/Shaw's + hundreds of PhDs).
Individuals should not try to compete in this area - at all. Just like you
don't try to build your own car, cruise ship, 747, iPhone or tank, you
shouldn't try and trade against stat. arb/HFT guys without the mental or
financial backing to hold your own shit.

Value-growth/passive works because the market comes to you - hat in hand
saying - here take my money please. Stat. arb/HFT also works, but it's much
harder, because you have to go to the market and make sure that it isn't you
that is saying - here take my money, please.

~~~
dkhenry
Hi there. I buy options all the time. I make lots of money doing it. You only
need a 1 to 2% change in price to make decent money when working with
options[1]. I don't know why you quote 5-7% as that's just not true. Even if
it was Stocks regularly move by that amount on a weekly basis. I know it may
not be much to some, but I made over 50k doing one or two options purchases
per month last year ( 2011, 25k base investment). I had to stop this year due
to me needing to liquidate my portfolio to free up some cash, but what your
saying is verifiably false.

1\. As of 13 November 2012 GOOG dropped by ~1% a $650 put options rose in
price by $1.70 had you owned just one contract you would have made $170 your
outlay for that would have been $1180 a one day gain of ~15% even subtracting
the trading fee of $10.00 to buy and $10.00 to sell you made $150 for a $1180
outlay or 12% in one day on one stock. This particular transaction is very
risky as there is no hedge against a decrease in the put price. You can do
that, but it will take more time to explain then I have right now. My napkin
math tells me you could have placed a less risky trade and make a cool $100 on
a 1% change with a 1K investment (i.e. 10%) on one day with minimal risk (risk
is if stock isn't volatile enough or trailing stops are set wrong) .

~~~
astrodust
You're playing with nuclear weapons. If you stand to make $10K profit, you're
exposing yourself to a much more massive downside.

Being _extremely_ careful will only prolong the inevitable crunch. You're
betting on a 1% hike that might be a 5% drop because some idiot in a bus ran
over someone important. That 5% drop could clean you out.

If you're betting on sure things, which means you're cheating somehow, then
options are your best bet. Hey, if it works for you, you've got a good racket
going, but most people will be absolutely destroyed.

~~~
dkhenry
Here is the quick and dirty recipe for making money off volatility.

Buy a put and a call option for the same strike price. On both options place a
trailing stop at a fixed point ( <\- that's where skill / statistical analysis
comes in ) After one of those two orders execute cancel the second order and
place a new trailing stop at a lower value to prevent additional loss.

If the stock goes up you sell the put and ride the call until the price drops
or you liquidate.

If the stock falls you sell the call and ride the put.

Your risk is total to the loss in time value of the option for the duration of
your trade , and is capped at a maximum of the sum total of the two trailing
limits on your initial purchase. If you would like me to run the numbers for
it please give me a security and I can even tell you where to set your puts (
I have computer programs I use to calculate reasonable stops , and execute
this particular strategy )

~~~
astrodust
So basically you can lose everything you put in. This is a slot-machine
strategy. It's a load of crap.

Anything bought on margin or of a derivative nature is like this. You can bust
out _hard_.

The thing with buying an actual security is a 5% drop is only a 5% drop in
value, whereas in an option a 5% drop could translate to a gigantic liability.

~~~
dkhenry
trailing stops limit your risk to a percentage of your initial investment. Its
the same thing as with purchasing a stock. That investment can also lose all
its value overnight. Its less likely to happen ( less risk ) and its also less
likely to really increase much ( less reward ). All options do is scale up the
risk/reward.

~~~
astrodust
It's extremely rare that a security loses all of its value in a short period
of time. In the last twenty years I can think of only a few occasions where
it's happened that quickly, and it's almost always front-page news.

Options, on the other hand, are _constantly_ declining to zero value. It's how
they work. If you end up out of the money at the end of the day, you bust out
on that bet.

------
chollida1
I like what these guys are doing, and we tried out their plugin for modelling.

However, you can't really do any modelling without factoring transaction
costs. For the average retail investor these fees kill the profit on many
otherwise theoretically profitable strategies.

~~~
dtromero
I'm interested in an in-depth tutorial that shows how to use the plugin to
perform this kind of analysis. While I don't work in trading, I can see a lot
of good uses for a tool like this while conducting other financial analysis.

~~~
karamazov
Send me an email, we'll talk - ben@datanitro.com

------
tocomment
Do brokers typically exercise your options for you automatically at the end of
the term or do you lose all the money if you forget?

~~~
karamazov
They'll usually either be exercised or settled for cash if they're profitable.
You should look into your broker's policy, though - if they're exercised, you
should be sure you have enough capital to cover the position.

You should also not be in a position to forget about your options - they can
move very quickly and forgetting about the position can cost a lot of money.

------
premalshah
Gr8 intro article. Couple of tips.

You can buy stock and sell out of the money calls against them, thus reducing
the overall purchase price. The stock can be called away if it rises above the
strike price thereby capping the profits. However, you can always roll the
options when you near the strike price and expiration. That way, you don't
loose the stock when its having a great run. This also works in the specific
case of sitting on FB stock from day one and being in a big hole at the
moment. Keep selling out of the money calls and having them expire worthless,
but keep rolling them to the next month when they get close to expiration.

------
xpose2000
I'm shocked to see Options being mentioned on hackernews. Though, I have been
doing options for the past 6 months. Previously I had never even heard of them
and knew nothing. Here are some insights as to what to expect...

Options are not for the faint of heart. If you are brand new to options and
are just starting out then I suggest having a friend/expert help you. I also
suggest you use very little money at first to get a feel for it. (Less than
$300 at a time). Otherwise you will lose money, and quickly.

The only way you'll get good at options strategy is to practice them. There
are no shortcuts to success (aside from getting lucky). You will likely lose
money at first, unless you have a good teacher to hold your hand.

There are a lot of little nuances and safer ways to make money with options
that I've slowly discovered over the past few months. Earnings are an exciting
time. One could safely make several thousand each quarter if they are smart. I
am just getting the hang of it after 2 quarters.

I personally stick to tech stocks like apple, google, and facebook. I usually
only do weekly options. Ideally, you want to dabble in stocks that move as
much as possible. (For example, if you had Apple PUTS this past week, you
would have made a killing. This is true for Straddles or Strangles).

After dabbling in options for 6 months I would say that the average person
should avoid them at all costs. You really can lose a lot of money and sleep.
You need to be a certain type of person to do this as a hobby.

For those of you willing to take the risk, best of luck to you. With options,
you are better to be lucky than good. It is true that you can make a lot of
money if you are smart and patient. However, you will lose a lot of sleep
either way.

------
wengzilla
You don't mention the downside of buying options... If it goes up, but doesn't
hit the strike, you lose all your money. Options are a pretty risky play and
it's typically not recommended that your average investor play the options
market.

~~~
minimax
From the article:

> There are lots of ways to combine options for different stock outlooks. Here
> are some common ones, _not accounting for option cost_.

He does mention it, but it's not very prominent. I also agree that not
including the cost of opening the position in the payoff chart is misleading
(and unconventional).

------
tocomment
I was wondering if a straddle on GRPN would make sense?

~~~
karamazov
A straddle is a way to trade volatility, so this makes sense if you think the
stock's volatility is higher than the market thinks it is. (In other words,
you'll make money if the stock will move more than the market thinks it's
going to move.)

~~~
dllthomas
Is anyone reputable selling options on bitcoins? I'd like to bet on high
volatility there...

~~~
marvin
I can sell you bitcoin options...but they'll probably be more expensive than
you want :P

~~~
dllthomas
Are you reputable? :-P

