Gyroscopic Investing

AdamA wrote:

Gosso wrote: AdamA,

Have you checked the "real" spread on the TLT options.  For some reason the very deep ITM options for TLT have giant spreads on them -- I'm talking 15-20%.  The spread for ITM options on GLD and SPY are much more reasonable at approx 1-2%.

For me, this almost makes TLT a non-starter for options, since if the TLT does perform well and ends deep ITM then you have to pay a 15% spread to close the trade.  Although, I suppose you could let the option expire and then sell the shares on the open market...

As the options get closer to expiration, the spread closes. 

I had a closer look at the TLT options and you're right.  But the spread is still greater than GLD and SPY.  Although there is a lot disparity, the options with increments of 5 have the most open interest and lowest spreads, but even a few of those have large spreads.  I guess this highlights the importance of limit orders.

Gosso wrote: AdamA,

Have you checked the "real" spread on the TLT options.  For some reason the very deep ITM options for TLT have giant spreads on them -- I'm talking 15-20%.  The spread for ITM options on GLD and SPY are much more reasonable at approx 1-2%.

For me, this almost makes TLT a non-starter for options, since if the TLT does perform well and ends deep ITM then you have to pay a 15% spread to close the trade.  Although, I suppose you could let the option expire and then sell the shares on the open market...

Also, I wouldn't use the deep ITM options.  Just at the money. 

Gosso wrote: AdamA,

Have you checked the "real" spread on the TLT options.  For some reason the very deep ITM options for TLT have giant spreads on them -- I'm talking 15-20%.  The spread for ITM options on GLD and SPY are much more reasonable at approx 1-2%.

For me, this almost makes TLT a non-starter for options, since if the TLT does perform well and ends deep ITM then you have to pay a 15% spread to close the trade.  Although, I suppose you could let the option expire and then sell the shares on the open market...

It seems that you found an inefficiency in the market.  With enough capital, you could be buying those in the money options slightly before the exercise date and just turning them into TLT for a handsome profit.

MangoMan wrote: If you are holding an ITM call option immediately prior to expiration, the last thing you want to do is let it expire, because then you get nothing and lose the premium you paid to buy the option. If you don't want to close out the position at a profit due to the spread, you need to tell your broker you wish to exercise the option, which will result in the shares being delivered to you at the strike price.

I thought most brokers automatically exercise the option if it expires ITM.  I'd definitely check with the broker to make sure.

Storm wrote:

Gosso wrote: AdamA,

Have you checked the "real" spread on the TLT options.  For some reason the very deep ITM options for TLT have giant spreads on them -- I'm talking 15-20%.  The spread for ITM options on GLD and SPY are much more reasonable at approx 1-2%.

For me, this almost makes TLT a non-starter for options, since if the TLT does perform well and ends deep ITM then you have to pay a 15% spread to close the trade.  Although, I suppose you could let the option expire and then sell the shares on the open market...

It seems that you found an inefficiency in the market.  With enough capital, you could be buying those in the money options slightly before the exercise date and just turning them into TLT for a handsome profit.

The reason for the large spreads is because there is literally no volume with deep ITM options for TLT.  Might have to do a little math to determine if it is better to exercise or take the spread hit.  I would think exercising would be the best move.

AdamA wrote: This portfolio returned about 100% over the past year, almost exclusively due to the TLT LEAPS which basically quadrupled (!) in value.  

I will sell all of the positions and repeat again this year.  I will sell the TLT and SPY LEAPS on Aug 2 (1 year + 1 day) b/c they were winners, and the GLD LEAPS tomorrow b/c it was a loser.

As interesting as this idea is to me, there is no amount of backtesting that would ever make me comfortable using it...unless maybe I was really really really rich, and using a very small portion of my invested money.

I'd like to point out that if you use deep ITM LEAP options, the effective margin is only 2:1.  So you're better off using a margin account with regular ETF's than paying the spread and slippage for LEAP options.

Now, if you want to use deep OTM LEAP options that are typically underpriced for fat tail risk, there may be something to it.

MachineGhost wrote:

AdamA wrote: This portfolio returned about 100% over the past year, almost exclusively due to the TLT LEAPS which basically quadrupled (!) in value.  

I will sell all of the positions and repeat again this year.  I will sell the TLT and SPY LEAPS on Aug 2 (1 year + 1 day) b/c they were winners, and the GLD LEAPS tomorrow b/c it was a loser.

As interesting as this idea is to me, there is no amount of backtesting that would ever make me comfortable using it...unless maybe I was really really really rich, and using a very small portion of my invested money.

I'd like to point out that if you use deep ITM LEAP options, the effective margin is only 2:1.  So you're better off using a margin account with regular ETF's than paying the spread and slippage for LEAP options.

Now, if you want to use deep OTM LEAP options that are typically underpriced for fat tail risk, there may be something to it.

Good point on the leverage.  This equation can estimate the leverage of the option:

{[(current stock price) * (delta value)] - (option price)} / (option price)

The ATM options for Jan 2014 are as follows:
TLT = 8x
SPY = 5x
GLD = 3.5x

It's not a perfect calculation, and I'm unsure how well it works for LEAPS since they have so much time value in the price, but it at least gives us a comparison.  To balance this to a 5x PP, we'd have to buy ITM for TLT, ATM for SPY, and OTM for GLD.

MangoMan wrote: You might be right about automatic exercising. Let us know if you find out more. I also think if you put in a limit order on the day of expiration closer to the ask price [5 to 10 cents], the market maker will often close out the trade anyway. Most of the time, they want to cancel out open interest without actually assigning the underlying.

I found this on the OCC website:

EXERCISE BY EXCEPTION
“Exercise by exception”? is an administrative procedure used by OCC to expedite the exercise of
expiring options by Clearing Members.1 In this procedure options which are in-the-money by specified
threshold amounts are exercised unless the Clearing Member submits instructions not to exercise
these options. “Exercise by exception”? is a procedural convenience extended to OCC Clearing
Members, which relieves them of the operational burden of entering individual exercise instructions for
every option contract to be exercised. It is important to note “exercise by exception”? is a procedure
between OCC and its Clearing Members and is not intended to obviate the need for customers to
communicate exercise instructions to their brokers:
“The exercise thresholds provided for in Rule 805(d) and elsewhere in the rules are part of the
administrative procedures established by the Corporation to expedite its processing of exercises
of expiring options by Clearing Members, and are not intended to dictate to Clearing Members
which positions in customers’ accounts should or must be exercised.”? (Rule 805, Interpretation
.02)

EXERCISE THRESHOLDS
Expiring options subject to exercise by exception use the following thresholds to trigger exercise:
Equity options: .01 per share in-the-money in all account types. Index options: $1.00 per contract inthe-
money (.01 index value) in all account types.
Expiring options are determined to be in-the-money or not based on the difference between the
exercise price and the “closing price”? of the underlying security.

The PDF can be found here: http://www.theocc.com/webapps/infomemos ... ate=201201

It seems that anything above ATM will be exercised, but still might want to call broker and conform all this.

MangoMan wrote:

Storm wrote:

Gosso wrote: AdamA,

Have you checked the "real" spread on the TLT options.  For some reason the very deep ITM options for TLT have giant spreads on them -- I'm talking 15-20%.  The spread for ITM options on GLD and SPY are much more reasonable at approx 1-2%.

For me, this almost makes TLT a non-starter for options, since if the TLT does perform well and ends deep ITM then you have to pay a 15% spread to close the trade.  Although, I suppose you could let the option expire and then sell the shares on the open market...

It seems that you found an inefficiency in the market.  With enough capital, you could be buying those in the money options slightly before the exercise date and just turning them into TLT for a handsome profit.

If you are holding an ITM call option immediately prior to expiration, the last thing you want to do is let it expire, because then you get nothing and lose the premium you paid to buy the option. If you don't want to close out the position at a profit due to the spread, you need to tell your broker you wish to exercise the option, which will result in the shares being delivered to you at the strike price.

I would just sell the option at the one year mark (with 6 months left to expiration).  That's enough time to let the spread close a bit.  Also, cushions you from time decay a bit.

So, this is depressing - I just passed the 1 year (long term capital gains) mark last week and the market has thoroughly tanked...

My options, which expire Jan. 19, 2013, are only worth $8,439, and you might recall they were purchased for over $10K.

Would anyone like to help me with an exit strategy?  Hold on and hope for some market movements, or just cut my losses now?  A few weeks ago I was looking at a slight (maybe 2%) profit.

I'm a great investor, but I'm terrible at trading... 

Storm wrote: So, this is depressing - I just passed the 1 year (long term capital gains) mark last week and the market has thoroughly tanked...

My options, which expire Jan. 19, 2013, are only worth $8,439, and you might recall they were purchased for over $10K.

Would anyone like to help me with an exit strategy?  Hold on and hope for some market movements, or just cut my losses now?  A few weeks ago I was looking at a slight (maybe 2%) profit.

I'm a great investor, but I'm terrible at trading... 

I'm not sure about the timing, but when you sell make sure to use a limit order and pick a price at around the mid-point of the bid/ask.  Typically the market makers in options do not advertise their true spread.  At least that was my experience with ITM GLD options.

Storm wrote: So, this is depressing - I just passed the 1 year (long term capital gains) mark last week and the market has thoroughly tanked...

My options, which expire Jan. 19, 2013, are only worth $8,439, and you might recall they were purchased for over $10K.

Would anyone like to help me with an exit strategy?  Hold on and hope for some market movements, or just cut my losses now?  A few weeks ago I was looking at a slight (maybe 2%) profit.

I'm a great investor, but I'm terrible at trading... 

I'd sell and rebuy similar options with later expiration dates...

Storm wrote: Would anyone like to help me with an exit strategy?  Hold on and hope for some market movements, or just cut my losses now?  A few weeks ago I was looking at a slight (maybe 2%) profit.

Rule #1: Don't hold LEAPs at or below 6-months to expiration.
Rule #2: Don't forget Rule #1.

See if you can sell a Jan 13 call against it and achieve positive theta.

AdamA wrote: I'd sell and rebuy similar options with later expiration dates...

I like this idea - how far out would you buy?  I think I would buy a 50/50 SPY/TLT split this time as well (and then sit in awe as GLD surely jumps... lol).

Storm wrote:

AdamA wrote: I'd sell and rebuy similar options with later expiration dates...

I like this idea - how far out would you buy?  I think I would buy a 50/50 SPY/TLT split this time as well (and then sit in awe as GLD surely jumps... lol).

This to me is just like making complicated bets at a craps table.  i.e., you're still probably going to lose.

Why not just take the relatively small loss before time decay really starts to eat up your positions?  

This is an embarrassing chapter for my investing experience.  I ended up with a >25% loss on these positions.  Variable Portfolios teach humility, that is for sure.

My suggestion to you - don't use options-based PP.  Personally I won't do this in the future.  Perhaps losing this small amount of money (relatively speaking, a few thousand dollars still seems like a lot of money to me!) will teach me to stay humble and keep all of my money in the PP, rather than gambling with some of it.

Storm wrote: This is an embarrassing chapter for my investing experience.  I ended up with a >25% loss on these positions.  Variable Portfolios teach humility, that is for sure.

My suggestion to you - don't use options-based PP.  Personally I won't do this in the future.  Perhaps losing this small amount of money (relatively speaking, a few thousand dollars still seems like a lot of money to me!) will teach me to stay humble and keep all of my money in the PP, rather than gambling with some of it.

Honestly, 25% doesn't seem like that big of a loss for an options based portfolio (I'd expect a lot of volatility). 

What was your exact strategy again?

Just curious.

AdamA wrote:

Storm wrote: This is an embarrassing chapter for my investing experience.  I ended up with a >25% loss on these positions.  Variable Portfolios teach humility, that is for sure.

My suggestion to you - don't use options-based PP.  Personally I won't do this in the future.  Perhaps losing this small amount of money (relatively speaking, a few thousand dollars still seems like a lot of money to me!) will teach me to stay humble and keep all of my money in the PP, rather than gambling with some of it.

Honestly, 25% doesn't seem like that big of a loss for an options based portfolio (I'd expect a lot of volatility). 

What was your exact strategy again?

Just curious.

I bought at the money call options about 16 months to maturity.  1/3rd each of SPY, TLT, and GLD.  My SPY options ended up making about 100% profit, while the other two made about 80% losses.  The idea was to keep them at least 1 year so that any gains would be long term.

Storm wrote:

AdamA wrote:

Storm wrote: This is an embarrassing chapter for my investing experience.  I ended up with a >25% loss on these positions.  Variable Portfolios teach humility, that is for sure.

My suggestion to you - don't use options-based PP.  Personally I won't do this in the future.  Perhaps losing this small amount of money (relatively speaking, a few thousand dollars still seems like a lot of money to me!) will teach me to stay humble and keep all of my money in the PP, rather than gambling with some of it.

Honestly, 25% doesn't seem like that big of a loss for an options based portfolio (I'd expect a lot of volatility). 

What was your exact strategy again?

Just curious.

I bought at the money call options about 16 months to maturity.  1/3rd each of SPY, TLT, and GLD.  My SPY options ended up making about 100% profit, while the other two made about 80% losses.  The idea was to keep them at least 1 year so that any gains would be long term.

How close to expiration did you sell them?

AdamA wrote:

Storm wrote:

AdamA wrote: Honestly, 25% doesn't seem like that big of a loss for an options based portfolio (I'd expect a lot of volatility). 

What was your exact strategy again?

Just curious.

I bought at the money call options about 16 months to maturity.  1/3rd each of SPY, TLT, and GLD.  My SPY options ended up making about 100% profit, while the other two made about 80% losses.  The idea was to keep them at least 1 year so that any gains would be long term.

How close to expiration did you sell them?

About 3 weeks to maturity.  I was originally planning on selling them earlier but congressional stupidity made me think that it would be better to hold off on selling them while the market was temporarily down due to the fiscal cliff.

This experience has taught me that I really dislike any investment that has a time decay.  I hate the feeling that you can either take a loss now, or wait and take a bigger loss (let it ride, so to speak) later.

So, I setup a real money options PP last year on December 28th.  Just sold the positions.  Here are the results for anyone interested.

It's really fun to watch these positions.  They are very volatile, but definitely "gyroscopic" as a whole.

All positions were at the money when I purchased. 

Initial (Dec 28, 2012)                                      Final (Dec 30, 2013)

SPY Jan 2015 Expiration---$1442                    $4363                                    Strike Price  $141
TLT  Jan 2015 Expiration--$1470                      $21                                                          $124
IAU  Jan 2015 Expiration--$1367                      $31                                                          $17

Total--$4280                                                    $4415


Gain--$135.17
Tax (15% capital gains)---$20

Net--$114. 
2.7% Gain
(commissions were included)

I thought it was cool that this portfolio had a gain (albeit small) in a year that the PP was down a little.

I also thought it was cool to watch the stock position completely carry the portfolio. 

AdamA wrote: I thought it was cool that this portfolio had a gain (albeit small) in a year that the PP was down a little.

The increase in options implied volatility accounted for the gain.  That may actually be a boon for using options so long as you don't buy or rebalance when the volatility is high.

So I did this again this year.  Very good results for 2014.

All positions were at the money when I purchased.  (Had to sell a little early because I needed the money, but I don't think it effected performance that much outside of the taxes).


Initial (Dec 30, 2013)                                        Final (Nov 18, 2014)                                                                                            Gain/Loss

SPY  Jan 2016 Expiration---$3227                      $5439                                        Strike Price 183            2 contracts                      +69%   
GLD Jan 2016 Expiration---$2977                      $1585                                        Strike Price 116            2 contracts                        -46%
TLT  Jan 2016 Expiration---$3224                      $10,462                                    Strike Price 102            6 contracts                      +225%

Total---$9428                                                    $17,486


Gain---$8058 
            85% Gross gain

Tax (28% short term capital gain tax)---$2256

Net---$5802
          62% Net Gain

(commissions were included).

     
Very fun to watch this from week to week, especially TLT. 

I just bought 2017 positions.  Will post again next year.

Cool.  So far you've been doing this during periods of relative low volatility right?  Have you ever bought the LEAPs during a period of high volatility?  Also, how have the gains been compared to the leveraged ETFs?

MachineGhost wrote: Cool.  So far you've been doing this during periods of relative low volatility right?  Have you ever bought the LEAPs during a period of high volatility?  Also, how have the gains been compared to the leveraged ETFs?

Good questions.

I've done this for only two years, each time buying and selling in late December, so, no, I haven't experienced much volatility just yet. 

I'm not sure how they compare to a leveraged ETF PP. 

I wish I knew of a way to backtest this strategy a bit.

I do this mostly just for fun.

Congrats, Adam!

One thing to keep in mind is that the leverage for at-the-money Jan '17 options on SPY, GLD, and TLT is roughly 5.0x, 4.6x, and 8.1x, respectively.  So to balance the leverage you'd need to go in-the-money a bit for TLT, or lower your weighting of TLT options.  Otherwise the LEAP PP will live and die by the TLT options, which thankfully worked out well over 2014.

How was your trade execution?  Were you able to do better than the bid/ask prices (I'm seeing spreads of between 8-10%)?

Gosso wrote: Congrats, Adam!

One thing to keep in mind is that the leverage for at-the-money Jan '17 options on SPY, GLD, and TLT is roughly 5.0x, 4.6x, and 8.1x, respectively. 

Very interesting.  This multiple changes, correct?

Do you think that in 2013 (the numbers are a few posts back) if I would have adjusted the weightings, I would have had a better result?  The SPY call did pretty well that year.  TLT and GLD were almost worthless at the time I sold them. 

How was your trade execution?  Were you able to do better than the bid/ask prices (I'm seeing spreads of between 8-10%)?

The spreads are steep.  I didn't calculate percentages, but the numbers include everything (commisions, bid/ask, etc).