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I was impressed with Bill Hatch's article Straddle-Strangle-Swap and have asked Bill to coach me in paper trading an account for the balance of the year. So, let me define the scope of this project, and publish an update each month for the rest of 2004. The paper trading goal is a monthly revenue of around $4,000. The expectation is that this revenue objective can be achieved with a trade size of 1000 shares in each of four different stocks. The paper trade model will use four stocks mentioned by Bill Hatch in the July article, namely Dell Computers (DELL), Home Depot (HD), Office Depot (OPD), and Disney (DIS). Stock options expire on the Friday before the 3rd Saturday of the month. In cases where the 1st day of the month is a Saturday, the options expire on the 2nd Friday. Therefore, the roll out date each month will be the Thursday before expiration. The initial paper trades for this learning exercise use the settlement prices from August 20th, 2004. A desirable characteristic is for the stocks to be tracking sideways. The following are daily charts for the four stocks in our model.
A Strangle is an option combination strategy where both a Call and a Put are purchased with space between the strike prices. For each of these paper trades, a Call is bought with a strike price that is $5.00 higher then the Put strike price. The Strangle is the insurance policy that limits the potential loss. DELL: In November options, bought a $37.50 Call (DLQKT.X) and bought a $32.50 Put (DLQWZ.X). This is the Strangle that limits the amount that can be potentially lost. In September options, sold a $35.00 Call (DLGIG.X) and sold a $35.00 Put (DLQUG.X). This is the Straddle, which is the first in a series of revenue months. The September Straddle will be bought back on September 16th, and replaced by selling an October Straddle. Home Depot: In November options, bought a $37.50 Call (HDKU.X) and bought a $32.50 Put (HDWZ.X). In September options, sold a $35.00 Call (HDIG.X) and sold a $35.00 Put (HDUG.X). Office Depot: In January options, bought a $17.50 Call (ODPAW.X) and bought a $12.50 Put (ODPMV.X). In September options, sold a $15.00 Call (ODPIC.X) and sold a $15.00 Put (ODPUC.X). Disney: In January options, bought a $25.00 Call (DISAE.X) and bought a $20.00 Put (DISMD.X). In September options, sold a $22.50 Call (DISIX.X) and sold a $22.50 Put (DIXUX.X). Here are the initial trades for the Straddle-Strangle-Swap, initiated with settlement prices from August 20th, 2004.
Commissions: Commission expenses will vary, depending on your brokerage. A typical cost would be around $25 for each of the trades shown in this table. Account Size: Most brokerages will require equity in the account to cover the maximum loss for each set of trades. In our model, the maximum loss could be $2,500 for each of the four stocks. So the minimum account size needed is $10,000. Account Balance: Can't complain that we are $500 to the good just by setting up the model account. Disclaimer: Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual record performance record, simulated results do not represent actual trading. Also, since the trades have not been executed, the results may have over or under compensated for the impact, if any. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. This article is published for educational purposes only. Article by Howard Arrington This is the September update of the paper trading model based on Bill Hatch's article Straddle-Strangle-Swap. I defined the scope of this project in the first section, and promised to publish an update each month for the rest of 2004.
The model is selling near term options in Dell Computers (DELL), Home Depot (HD), Office Depot (OPD), and Disney (DIS), and holding longer term options as an insurance policy. The plan is to execute a calendar roll-out each month by buying back the short options on the day before expiration, and selling short options one month out. The roll-out of replacing the September options with October options was carried out on Thursday, September 16th, 2004. The October roll-out will be carried out on Thursday, October 14th. This is where the model stands.
A desirable characteristic is for the stocks to be tracking sideways. This was the case in the past month for Dell, Disney, and Office Depot. The stock that trended was Home Depot, possibly benefiting from increased demand for building materials because of the three hurricanes.
The short HDIG Call at $35 is the trade that was a costly $2000. The model will resell the same strike in the October month with the expectation that Home Depot prices will return to a more average price. Summary:
This is the October update of the paper trading model based on Bill Hatch's article Straddle-Strangle-Swap. The model is selling near term options in Dell Computers (DELL), Home Depot (HD), Office Depot (OPD), and Disney (DIS), and holding longer term options as an insurance policy. The plan is to execute a calendar roll-out each month by buying back the short options on the day before expiration, and selling short options one month out. The roll-out of replacing the October options with November options was carried out on Thursday, October 14th, 2004. The November roll-out will be carried out on Thursday, November 18th. This is where the model stands.
DELL continued to trend upward in October which hurt HDJG.X. Also, Disney decided to trend upward away from $22.50 and that contributed to a loss for the month in Disney. Since DELL and HD had strangle legs expiring in October, those two symbols will be closed out and the model will continue with just ODP and DIS for the balance of 2004. The $22.50 strike in DIS which lost $1425 in October will be resold in the November option. There is a good chance that DIS will return to a more average range price, which would recoup the October DISJX.X loss. Summary:
DELL and ODP basically traded sideways and produced a profit for the model. HD and DIS trended upward and produced losses, which is unfortunate yet something that happens. The model is fulfilling its educational objective by illustrating both the reward and the risk. Here are the net trades for the options I (Bill Hatch) traded last month (September 2004) .... Dell Computer: I bought back the October $35.00 Calls and sold November $35.00 Calls (DLQJG.X and DLQKG.X respectively) for $0.95. Similarly, I bought back my October 35.00 Puts and sold the November Put (DLQVG.X and DLQWG.X respectively) for $0.90. That gives a net of +$1.85 to roll the straddle over one month. Office Depot: The $15 Calls (ODPJC.X and ODPKC.X) sold for $0.50. The $15 Puts (ODPVC.X and ODPWC.X) sold for $0.70 for a net $1.25 to roll into next month. I netted $1.70 rolling MOT (Motorola, Inc.), and $1.20 rolling DIS (Walt Disney Co.). My personal profits on these are marred by the Home Depot. The others have all returned a good profit. Last modified 10/27/08 11:36 AM |
