Ask Us Anything (Well, Not Anything)

by CC October 28, 2011 1:08 pm • Commentary

Dan and I answer alot of emails from subscribers looking for insight into our trading strategies and options trading in general. We’re going to do occasional posts where we highlight some of these questions and our answers. We’ll also open up these posts to comment threads for additional questions. We are not registered investment advisors and will not comment on specific stocks or trade ideas other than to offer general advice on options and trading in general.

Please keep the comments on topic and related to Risk Reversal and options trading in general. If your comment is off target, it MUST be funny. And know that we’re a tough audience. We’re also using this as a test for turning on comments site wide so please keep that in mind as we won’t be able to do that if this turns out to be a huge job of moderating comments. Ideally we’d like the comments to be the new forum for answering questions.

(Questions and answers below have been edited for clarity, grammar and spelling, and specifics are sometimes left out because they don’t matter)

I’m a new subscriber with a simple (I think) question: What portion of my trading portfolio should I commit to any one position? – K
Pretty tough question but I think the answer is probably 1 or 2% and when you have a lot of conviction a little higher…..but on most options trades you should risk what you are willing to lose because in many instances you will lose all of your premium. -Dan


How much of your holdings are just longs for a good long while, and perhaps dividends, percentage wise. And how large percentage wise are your various sprinklings of event driven option trades? I mean when you put on a low conviction trade that has a high payout, are you doing say 1% of your total, or even less? -MO

I do keep some stuff in longer term portfolio that can also be spec that I dont want to look at, if that makes sense….stuff in my trading portfolio I am constantly trading, as you can see from my style on the site….but all speculative stuff in my opinion should not equal more than 10% of all holdings. I sold Sprint call spread yesterday because to me the story changed and I think the likelihood of the Feb 4.5 call being in the money ain’t great. I dont buy and hold, other than mutual funds or Spys… I generally trade the market in short cycles like 6-12m months…this is not tax advantage and not recommended for most people….as for the options trades I usually decide to risk 1-2%, but that can depend on recent performance, when things are not going great I do them smaller and when I have more winners in a short period I do them smaller……make no mistake about it, I am a trader, and nothing I do on the site is meant to be replicated in its entirety….we want readers to take bits and pieces and do their own trading/investing. – Dan


When doing a call or put spread, when the short leg reaches it’s strike, this going to be the most profits you can get even if the stocks continues to go up right? – MG

Yes, at expiration, but if it hasn’t expired yet the farther the stock goes through that short strike the closer to max that spread will price out. The reasoning being that that spread will still have premium associated with the stock reversing. So for example on that AMZN put spread, if the stock had opened at 180 instead of 200 that spread would have been 10 dollars, as there would be very little chance the stock would finish above the short put strike. With it at 200 it was only worth 9 or whatever as there was still a 10% chance that the stock would finish above the short strike by expiration on Friday. -CC

Ok because I have a call spread on at the 37.5/39.5 Nov strike. If the markets continue to go higher, it will go through the 39.5 level, but bc we are not that close do the expiry, I should keep it on until it starts reversing then take it of. Got in that trade last friday when the stock came back up above 36. But I see resistance at the 41 ish levels. -MG

Yeah exactly, right now at 39.5 the call you are short still has premium on it, that premium declines or increases based on 3 factors, stock price’s distance from the strike, time to expiration and volatility in the option. So as the stock goes through that strike to the upside the premium will decrease and your spread would approach 2 dollars, same with if the stock stayed slightly above 39.5 and we got close to expiration. -CC


I have a question on butterflies.  On the put butterfly that was suggested on the CMG ( I did the 260,240,220), once you put it on, and the underlying goes the opposite way, (up 8 pts yesterday), is there a way you alter your position by adding or selling more puts at the same or different strikes  to counteract it moving up when we wanted it to go down.  I didn’t put much on and am still learning options.  I know I still have until August for this to play out but knowing it’s a beloved stock and over the $300 barrier, it may stay on the uptrend for a while. -TT

I used the fly because I wanted to isolate a certain range back to support without putting out a ton of premium….if I were to assign probabilities to the stock going to 250, where you would get the max payout on that fly then that payout potential is massive if you can assign greater than a 20% chance, which I did, and the market did when you consider what the the delta of the fly was. I also thought there was a good chance that the stock went to 300 and made a new high if the market stabilized, which it did. As for altering, that could get a little complicated and if you still have conviction I would just add at same strikes, but stock is up 5% now and becomes less likely. This is a tough one and I have on, I am just staying put now -Dan


I  had bought options based on take out rumors and thought that stock would trade to $135 or in next month. When stock was trading around ~$123ish, I sold DEC $90 Put (~$3) and bought DEC $170 calls (~$3) for $0. Stock got crushed and I was a bit slow and did not get out of the trade. Hypothetically should I hold on it or cut losses? Could I get assigned the stock if it trades below $90 before expiration and what you think the chances are? -A

As far as cutting losses I would think about risk reversals very similar to owning the stock, if you had bought the stock at 123, where would you sell it if it sold off? For instance if you bought 100 shares for $123, that would cost you $12,300 and if the stock sold off to 110 then you would be down 13 on 100 shares or $1300. So I guess if you were to use a mental stop before entering the trade, where would you have stopped yourself out? Down 10%? If so then you should probably be cutting your losses, or some of them here… for the chance of being assigned, the Dec 90 Put has about a 22 delta to it, so the options pricing models are only saying there is 22% chance of that strike being in the money on Dec expiration…..even though the stock is almost 30 off of the recent highs, it is 50 off of last year’s lows….I think you want to be very careful selling puts in this market environment, if you notice on the site I am not suggesting many trades that entail selling puts as a means to get long, I am worried about tail risk. At this point the risks to your trade are to the downside as the likelihood of the dec 170 call being in the money are not great as they have a 9 delta to them… I guess to sum up, if you reached the point in your mind where you had a mental stop on the downside when you entered the trade, or maybe that number was a dollar value of losses then you probably should consider cutting your losses…..If you think the stock doesn’t have much more downside then maybe take your chances that the stock doesn’t go below 90 on dec expiration and stay short…but maybe cover 1/4 or 1/2 of the position so that you don’t kick yourself later for not moving your feet. While the general rule of thumb is not to sell options with a single digit delta, that call trading at 1.00 seems very tempting…..if there was a deal for the name at this point do you really think it would be for a 50% premium?



What are your thoughts on collaring my shares of AAPL? Or collars in general. My view is that AAPL won’t go higher than something like 450 anytime soon, so I’m thinking of something like selling Jan 460 for 12.50 or so (currently at 10.65) to buy the Jan 340 put. Or maybe sell the Jan 450 Call to buy a 345 or 350 put. Thinking about try to put it on when the stock hits 410 or 420 soon. -MO

I like collars and think they make a lot of sense….I generally like to use them tactically around events like earnings or if I think the market has gotten a bit extended…..I usually like to use zero cost, meaning I pay nothing for it, the call premium that I take in is equal to the premium I  pay for the put.


The trade from this morning sounds great but I don’t have a margin account so I can’t partake in the naked spread. Do you think it’s still worth it if I just bought the Jan 12 $30 call for $3.35? -EB

Here is the thing, what I like about this trade is that if there is a cash deal that all the time value will come out of the Jan13 upside call and because of the structure is why u can basically get it on for even money…..I am not a fan of the company and basically feel there only way forward is to be taken out…..if you have to play I think calls or call spreads make the most sense in an effort to define your risk……without a deal this stock prob goes to teens. – Dan


On your spread trades, do you hold them until options expiration or if they hit their target before do you close it then? -G

I treat spreads as I would treat an outright option that I own or the stock for that matter. I usually make an estimate of the current gain or loss I have in the position relative to what I expected to achieve and what I was willing to risk…..for instance the other day i wanted to make a bearish bet into INTC’s earnings but did not want to short the stock as I thought if there was any good news the stock could bounce, as it did….the Aug put spread that I bought lost half its value on the bounce, this morning I sold half of the position as I thought the stock was not likely to be back down to those strikes… point is I rarely wait til expiration, if I paid .40 for a spread and it is worth 1.20, but I have the potential to make another .80, at that point I have to make a decision whether the risk reward relationship still stands, now I am essentially risking 1.20 to make another .80, thats prob not a trade I would put on at that point, but also depends on my conviction level and why I own the spread. -Dan


I have a quick question about the recent Netflix earnings trade that you posted. You mentioned that if the stock is at 255, we make 8.90. But you sold it only at 3.00 when it was above 260 on expiration day. I want to know why you didn’t sell it off the next day (post earnings) itself when it went down to 253 and came back to 255? When it came back to 255, why didn’t we make the maximum profit of 8.90? Even if the stock hits 255, it doesn’t guarantee the maximum profits? Does it have to do with the days to expiration? Can you briefly explain? -MD

At 255 with 3.5 days to expiration there is still plenty of extrinsic value (volatility and time) in the two 255 puts that you are short… the time value wont come out until expiration and the likelihood of the stock closing at or near the strike can be better determined.  Because the options were weekly and expiring on Friday I did not have a lot of time for this to work out. Butterflys are difficult enough that you have to pick a range where you think the stock will go and settle, but you are really threading the needle when you have to get the abbreviated time right…that is why I put the disclaimer that this trade structure is not for everyone.  So at some point I made a decision that making 3x my money was sufficient and that the risk reward did not staying long the fly to play for the stock to pin to 255 on expiration. -Dan