PCP – how I adjust a long stock position

Posted by: Admin: "The Vol_Trader"  //  Category: Trade strategy

There’s many articles written on how to “repair a broken stock” out there.  Click here for a good recent example from The Motley Fool.  They instruct you to buy one ITM call (one for each 100 shares you’re long), and sell 2 OTM calls.  The only problem with this strategy is that it still leaves you with lots of downside risk.  The above mentioned article states if the underlying goes down all options expire and you lost just your commissions, try again and unfortunately your underlying’s value has lost even more.

I like to protect myself a little more than that to the downside, even if I’m bullish (why else would I own the stock?).   The easiest way to protect a stock from downside risk is to buy a put.  Buying a put makes me short theta which I hate.  I feel there is only one thing that is guaranteed in the market, time will pass.  I want to be long Theta whenever possible.  So, how do I offset the cost of my put and get short theta?

First I want to make my predictions as to where the underlying will go. Second, and equally important, I predict what IV will do.

Looking at the daily and weekly charts (click any picture to enlarge) with volume profile, I’m predicting PCP will stay in a range with support at 102 and resistance at 120.  Earning are on 7/22/10 and historically, it has not made major moves after earnings.  Volatility has also been in a range for some time and historically, Vol drops but not much after earnings. 



Using the above predictions, I want to create a trade that profits if PCP stays in a range, and if Vol stays the same or drops.

Here’s the trade. 

  • I own 100 shares of PCP, currently trading at $107.79. (My price is $121.40)
  • +1 Sep $105 put.
  • +4 Sep $120 call.
  • -5 Sep $110 call.

The P&L looks like this for the long stock (obviously) below:


The P&L looks like this after I added the options, below: Notice that this trade is ‘profitable’ in the range that I anticipate.  If the underlying stays in the range as I predict, my trade that is currently around -$1,400 will be -$300.  Then in Sep, I can put on a similar trade again as long as my predictions have not changed.  I now have a limited risk trade that I can manage or stop out if PCP should rally hard.  Synthetically, you’ve created a broken wing butterfly (long stock and long put is long call +1 $105call / –5 $110 call / +4 $120 call).


Also, the Vega is pretty neutral.  At first glance at the chart of Vega it looks exactly the opposite of what you want.  It’s short Vega to the downside and Long Vega to the upside, however, with further examination, you’ll notice the largest value for Vega is +/- only $26.  See below:


As usual, I’ll keep you posted as to adjustments and management. 

* Here’s an idea for discussion based on the above.  You can use this strategy to put on a bearish synthetic broken wing butterfly and own shares of your favorite dividend paying stock.

*this is not a trade recommendation, education only.

An update on V and ASML trades:

Posted by: Admin: "The Vol_Trader"  //  Category: Trade strategy, Volatility Trades

Sorry for my absence lately.

After Jul expiration I wanted to update you on two trades, V (Visa) and ASML. 

V update:  This trade turned out to be a good example of my management and trade adjustments that I regularly do, and ended with a little good old fashioned luck…

As you know, this trade was placed on 5/21/10 with a bearish bias (Click here to see). 

image Four days after I put the trade on, I took off 3 of the 10 contracts for a small profit.  Often, if the trade goes well right away, I’ll take off a small portion for a quick profit and let the rest go for additional profits.  In mid June V went up and I had an unrealized loss with Jun expiration approaching.  6/14/10 produced a nice down day and although I was still at an unrealized loss, I was able to take advantage of the down day to produce a favorable roll, buying back my short Jun options and selling up and out Jul options. (Click here to see roll) Immediately after this, V rallied and then dropped back.  On the drop back, I was about breaking even and I decided to let this trade continue expecting a further drop in V and the market in general.  I was wrong and the market and V had a strong rally into Jul expiration week. I like to roll my shorts by Tues prior to expiration.  I analyzed rolling my short Jul options out to Aug or up and out to Aug but nothing looked good to me.  At best I would have locked in a smaller loss than I currently had.  My two choices were to close for a loss or hold on a few more days hoping to get lucky with a drop into expiration as my trade was purely a directional gamma play now.  Normally I would not hold a trade and hope for a lucky ending but in this case I didn’t see much risk to the upside and my alternatives were not good as I described above.  Additionally, since I was able to take some profits on the first three contracts, I had a little bit of a buffer.  Well, I got my wish and expiration Friday turned out to be a great day.  Right at the open I took off five of the remaining seven contract spreads for a nice profit, and later in the day, I took off the remaining two spreads for an even larger profit.  In total, I ended up with a $1,442 profit. 


ASML update: I’ll jump the conclusion and then tell you how I got there.  As of Friday’s close I’m down $246 on this trade.  This is not bad considering that this trade is bearish and long Vega.  I put this trade on with ASML at $30.28.  Friday ASML closed at $30.92.  Clearly my short delta didn’t help this trade.  When I put on the trade I was long Vega and this trade remained long Vega throughout the whole time.  Implied volatility dropped from 42.38% when I placed the trade to 36.08% at Friday’s close.  So how did I (about) break even when delta and vega moved against me?  A few things helped.

  • First and most important, SKEW.  Click here to see my initial post where I described putting on trades that have ‘a slight advantage based on volatility’ skew.  By selling higher Vol options and buying lower Vol options, when the skew reverts you benefit. 
  • Second, trade management:  I took some early profits similar to the V trade.  (Click here) Note: the long calls I bought as cheap protection ended up worthless.  Had the underlying moved up a lot more they would have come into play, but the small rally didn’t affect them.  I lost a small amount on them.
  • Third and final reason, time decay.  I almost always like to start with time decay working in my favor, negative gamma trading.

Just like the V trade, I had considered rolling my short Jul options to Aug but again there was no favorable roll and I would have locked in a small loss at best.  I decided to close the trade for a small loss on expiration day.  As most of you know, trading a liquid underlying’s options on expiration day it is difficult to get advantageous pricing as the market makers (and their computers) know you need to get out.  In ASML case, it’s not so liquid so that makes it virtually impossible to get out with good pricing on expiration day.  With that said, I’m currently long Sep puts naked as my short Jul I closed for $0.05 (Commission free to close short $0.05 options, thanks Tom at Thinkorswim) and I couldn’t sell my long Sep puts for a price I wanted. I now have upside risk.  I’ll close these remaining Sep puts at the open Monday unless ASML is going down, then I’ll monitor them and perhaps get lucky again. 

Note, these are not trade recommendations, click for legal disclaimer.

ASML – a trade management update.

Posted by: Admin: "The Vol_Trader"  //  Category: Trade Management

I originally put on a diagonal trade with multiple strikes in ASML on 6/17/2010.  See that trade CLIICK HERE:

Then, on 6/24/2010 I posted an update in which I bought calls as upside protection, CLICK HERE:

I originally put on the trade with ASML trading around $30.30.  ASML quickly moved up to a high of $31.41 in just two days producing unrealized losses.  From then on, things started going more in our favor.  As I write, ASML is at $28.20.

Yesterday produced a nice gap down day.  Between yesterday and today I took off a few spread contracts in both spreads for a nice profit.  Here’s what happened:  The long Oct puts benefited from their short delta AND their long Vega while the short Jul puts have benefited from their long theta and hurt by their short Vega and short delta.  The profit on the long Oct puts is significantly more than the loss of the short Jul puts. 

Originally I put on the Jul/ Oct 27.5 / 30 put diagonal for $2.10 debit and sold it for $2.69 credit, profit $0.59 (+28%) per spread.  I put it on 24 times and have sold 5 spreads so far.

I bought the Jul/Oct 30/35 put diagonal for $4.40 debit and sold it for $5.00 credit, profit $0.60 (14%) per spread.  I put this one on 13 times and have sold 5 spreads so far. 

Currently, I’m in no rush to get out as I’m very close to my short strike and collecting lots of theta as Jul expiration is only 16 days away.  The Thinkorswim P&L chart looks like this: (Click any picture to enlarge).


Note, the Thinkorswim analyze tab, unfortunately, does not have the ability to show profit and loss due to previously closed trades, only currently open positions.  There’s a way around this I’ll post at a future time if anyone is interested.  The above chart does not take into account the previously closed 10 spreads.

The Calls that I bought as upside protection obviously did not come into play and are a write off as insurance not used.  I’m okay with this.  Just like auto insurance, you hope you never need it.

Again, I’m in no rush to sell more as expiration comes closer.  I like to identify risk throughout the course of a trade.  The only major risk now is a collapse of Oct IV that could possibly hurt this trade.  In my opinion this is a very small risk but I’ll monitor and get out if I see a decreasing  trend in IV forming.  Also, if there is a Moderate(most likely news driven rally) in ASML my short delta will hurt a bit. If there is a major rally in ASML my long calls will benefit me but a drop in IV will still hurt.

Not a trade recommendation.  For educational purposes only.  Legal disclaimer, click here.