Monday, 12/15

Goldman Sachs (GS) comes out with earnings tomorrow morning and I thought it might be a good opportunity to sell volatility ahead of earnings.  With the historical volatility currently at 122 and the IV at about 100, this high volatility allows us to collect more premium than in a more normal, low volatility environment.  Also, being that this is options expiration week, the front month options don’t have much time value.  I figured I wanted to sell out of the money puts and calls (strangles) and hope that the price of GS after reporting earning remains within the range of my strikes and that they will expire worthless in the next 4 days.

At the time of purchase GS was trading at $65, a nice mid-strike price to work with.  I sold 50 of the 85/45 strangles, giving me a wide $20 range (30% of the current price) for an income premium of $3,600.  I also got a little riskier yet smaller by selling 10 of the 75/55 strangles for an additional $2,640 of collected premium. That position gives me a $10 range on both ends (15% of the current price).  So basically, I’m betting GS won’t move more than 15% by Friday.

If stock price starts to reach the edge of the inside strangle (75/55) I will look to get out at my break-even points ($77.64 and $52.36) on this position but keeping my premium on the wider strangle.  The break-evens on that strangle are $88.60 and $41.40.

I’m liking the options action during expiration week, esepcially the selling of options.  Since there is not much time value left the premiums are not as juicy, but the probabilities of success (expiring worthless) are higher so these trades are more conservative in that regard.

Tuesday 12/16

GS closed the day yesterday up to $66-ish and this morning it’s up to $71 after the earnings announcement this morning.  Of course, the puts are worth much less now, down about 70%-90%, yielding a nice gain so far. And the 85-strike calls I sold also came down in value due to a decrease in volatility, even though they are closer in-the-money now.  The 75-strike calls I sold however are up, but not by much, only from 1.15 to 1.40.  The decrease in volatility has helped to minimize their upside gain.  It’s Tuesday and I’m thinking of just holding everything to expiration (this Friday) so they expire worthless.  The only one that worries me is the 75-strike calls that I sold, though the stock would have to go up another $5 to start to reach my break-even point and I’m somewhat reassured in that these contracts expire in less than 4 days.

Tuesday, 12/23, after expiration

Well, I wish I had covered those $75 calls before expiration, GS went all the way over $80 by the end of the week and never came down.  So those calls expired $5 ITM (in the money) and by Monday the calls were exercised and I found myself short 1,000 shares of GS!  Luckliy though GS came down near $75 again today and I covered my short position for a small $300 loss.  Not bad considering on Friday I was sitting on a $5,000 loss!  So overall, I squeaked by with about a $5,000 one-week gain.  I just felt GS was overpriced at $80 and I’m glad I held on enough at least to cover my short instead of covering on Friday and taking the $5,000 loss.

I think the takeaway for me was that when you’re selling volatility before an event, after the event happens and the volatility comes back down you need to take off the nearest-risk position (in this case, being short the $75 strike) and watch the rest of the positions closely until expiration.  I would have been happier taking the loss on covering the $75 strike and sleeping more easily for the rest of the week.  And I feel lucky GS eventually came back down to $75 after my calls were exercised.  Because this was an event-driven play, once the event plays out you should take off some or all risk since it the position was based on a short-term thesis.

Even though the stock rose 8% shortly after I sold the calls, the fact that the calls only rose 21% is a testament of the power of volatility in pricing options.

Remember that APA 125/135 call spread that I mentioned earlier as having sold for a 100% gain? Well, turns out that same spread expired worth $9. I bought it for $1, sold it for $2. Had I held on, I could have sold it for $9 for a 800% gain! That’s one thing I liked about the trade when I put it on in December: it had a potential 9:1 profit ratio and it fulfilled it’s full potential last week as APA closed over $140.

Now it’s always easy to look back and kick yourself for not holding on longer, but a 100% gain is a pretty juicy gain and one you’re going to want to keep. So, what I’ve heard that other traders do is if they have a position that has doubled in value and they think it may run even higher, they will sell half so at worse they break even if the rest of the position becomes worthless. Meanwhile they’re still in the game with the other half. That would have been nice if I had done that here.

I sold my Apache April 135/125 call spread yesterday after I had reached a 100% gain on it. I could have probably made more as oil is up even higher today, but I wanted to lock in a rare profit for me.

This trade was very attractive to me at the time when I bought it in December, it had a potential 900% gain if the stock hits 135 by April expiration, but as March options are going to expire soon theta is going to kick in pretty quickly and if I don’t start to get in the money soon then I’d be really hurting. APA has already had a nice run-up lately and in this market things don’t continue going up for very long so I wanted to take the profit I had while I still had it. Looking at it today, I would have been up only 85% so I’m glad I sold when I did.

This was perhaps the longest time period of an option I had ever purchased: 4 months! At the time I bought it APA was over $100 a share, then it swooned downed to 90 then recently rallied with oil and natural gas rallying. It’s been a wild roller coaster ride but buying that extra time allowed me to get into or near a profitable price point through the crazy volatility.

NOTE: after taking a second look at this chart I just noticed a couple of “hammers“. I just read about hammer and hangman reversal signals earlier this week in TASC and this chart has a good example of two hammer trend reversals.

RIMM’s up 15% after hours after posting earnings. This morning I bought some Jan 130 calls just because

1. I liked how the market responded to Oracle’s earnings yesterday and that instills confidence that the tech sector is still strong
2. The VIX is dropping which means a more saner market ahead of us
3. And, well, despite my better judgment, it just felt good, and I still love my Blackberry

I’m hoping I will have doubled my money by tomorrow morning. This is one of my favorite stocks to trade.

… The next day …

I sold out early this morning for a 54% gain when the stock was hovering around $117, but, hey, it was a one-day gain and in this wacky market I’ll take what I get. The stock’s at $119 now 2 hrs before market close which would have given me a 100% gain on the options but I’m OK with it. I think with volatility dropping though I would be more apt to hang on longer and not be so trigger happy.  In retrospect I should have just put a trailing stop on it to protect my profits while letting it run, but I’m not too familiar with that feature on optionsXpress yet but that’s something to study up on over the weekend.