[pico]

Originally Posted by Ganchrow

With a naked put you have limited up side (equal to the premium received on the put) and downside limited to the price of the stock minus the put premium received.

With a covered call, your upside is limited (if the stock price goes to infinity, you make money on the long stock and call premium, but lose money on the short call), and your downside is limited on;y by the approximate value of the stock (if the stock price goes to zero you receive the call premium but lose the value of the long stock).

The two are identical from a risk standpoint.

i asked my friend at GS. and i am wrong, you and jc are right. i feel pretty stupid now. i guess i really need to reread Hulls book again.

[Ganchrow]

Originally Posted by picoman

i asked my friend at GS. and i am wrong, you and jc are right. i feel pretty stupid now. i guess i really need to reread Hulls book again.

Yep, it sure sounds like you do.

[pico]

Originally Posted by Ganchrow

Yep, it sure sounds like you do.

you don't have to rub it in.

[Ganchrow]

Originally Posted by SBR_John

However, covered call writing does not expire and settle like a short Put does. So the covered write is slightly safer overall. You can continue to write more calls in the covered write scenario. You can't with a short put.

Well, the call expires ... and you can always write more puts.

[ShamsWoof10]

Originally Posted by picoman

i asked my friend at GS. and i am wrong, you and jc are right. i feel pretty stupid now. i guess i really need to reread Hulls book again.

Well if it means anything to you or not I have more respect for and give credibility to you for admitting and updating your error... A lot of people don't admit their errors.... Just a thought...

[compaqDikk]

don't listen to JJ about the market


made 5.45 an hour sweeping tickets at the NYSE> wore a cheap suit one day and thought he could fool people

[BatemanPatrickl]

Originally Posted by compaqDikk

don't listen to JJ about the market


made 5.45 an hour sweeping tickets at the NYSE> wore a cheap suit one day and thought he could fool people

Least he cleared a couple dollars for the day

[pico]

you need to spend more time editing that pic.

[compaqDikk]

that is authenitc, not doctored. that's really how his warddrobe looks. all moldy n shittt from flooding basement. and apparently the shades were on due to light sensitivy with all the flashing lights

[Ganchrow]

Originally Posted by Ganchrow

With a naked put you have limited up side (equal to the premium received on the put) and downside limited to the price of the stock minus the put premium received.

With a covered call, your upside is limited (if the stock price goes to infinity, you make money on the long stock and call premium, but lose money on the short call), and your downside is limited on;y by the approximate value of the stock (if the stock price goes to zero you receive the call premium but lose the value of the long stock).

The two are identical from a risk standpoint.

Before Korchnoi shows up and makes this point himself, I'll just note that technically speaking the put/call equivalence relationship (aka "put/call parity") only truly holds in the case of European options (where contracts may not be executed prior to the expiry date), or in the case of American options on stocks not paying dividends (where early expiration, silly pathological cases aside, is never optimal).

[SBR_John]

Ganch or JC, something is kind of bugging me on options.

Dividends make for some unique trading opportunities. I'm not really sure how the market makers can hedge all the risks.

Lets take a real life scenario;

ATT is at 41.85. It goes ex dividend Thursday less .355. The July 40 calls trade at 1.90 on the bid.

Here's the trade question:
If a trader shorts that call a minute before the end of trading on the day prior to the ex-dividend, is the only risk that would prevent a profitable close at the open trade is if the stock opens .355 higher and/or there is an expansion in the premium? The fact is the stock is going to open artifically lower by .355. But the option does not spin off a dividend so its lower open is for real.

I know the max profit is limited to the .355 and it will certainly be less at the ask or in the opening rotation. But aside from those risks it still seems like an excellent trade. What am I missing?

[Ganchrow]

Originally Posted by SBR_John

Ganch or JC, something is kind of bugging me on options.

Dividends make for some unique trading opportunities. I'm not really sure how the market makers can hedge all the risks.

Lets take a real life scenario;

ATT is at 41.85. It goes ex dividend Thursday less .355. The July 40 calls trade at 1.90 on the bid.

Here's the trade question:
If a trader shorts that call a minute before the end of trading on the day prior to the ex-dividend, is the only risk that would prevent a profitable close at the open trade is if the stock opens .355 higher and/or there is an expansion in the premium? The fact is the stock is going to open artifically lower by .355. But the option does not spin off a dividend so its lower open is for real.

I know the max profit is limited to the .355 and it will certainly be less at the ask or in the opening rotation. But aside from those risks it still seems like an excellent trade. What am I missing?

What you're missing is that the market is already extremely efficient. Rest assured that a coming stock dividend will be priced into the option valuation substantially more accurately than a typical individual investor would be able to accomplish.

Thinking you'll be able to beat the highly paid institutional and exchange trader professionals to a very basic option arbitrage is akin to thinking you can consistently make money off Pinnacle based on NFL injuries you first read about in the Sunday morning paper.

[SBR_John]

Originally Posted by Ganchrow

What you're missing is that the market is already extremely efficient. Rest assured that a coming stock dividend will be priced into the option valuation substantially more accurately than a typical individual investor would be able to accomplish.

Thinking you'll be able to beat the highly paid institutional and exchange trader professionals to a very basic option arbitrage is akin to thinking you can consistently make money off Pinnacle based on NFL injuries you first read about in the Sunday morning paper.

OK but something has to give. That July contract is already void of any premium. Expanding the premium could account for some of the closing of the spread but not .35 worth.

Even the July 35's are at par. Certainly the premium can not be expanded to cover the dividend in that contract.

I *think* the risk to the trade is in the opening. I know they are fairly priced. However, with American style contracts they can not go below the bid/ask or they will be exercised. The July 35's are bid 6.80/6.90 with the stock at 41.85. It is not adjusted for the dividend. Its simply a deep in the money call with 13 trading days left on a low beta stock.

I guess I'll short a few at the close tomorrow and see if it opens the ex-dividend session .35 lower, assuming there is a flat open. (watch it gap open down $2)

[BrentCrude]

On the pink sheets which are the riskiest of the risky penny stock where very little information is disclosed by the company you can make or lose some serious $$$$$$$Even the brokers make you sign a disclaimer that the trade was unsolicited by them.You can buy shares at .0001 of a penny where 1 million shares cost $100 plus commission.

The sleezy penny stock market makers love this kind of stock because they have it where there is a big spread between the ask and bid price where the suckers have to buy high even at .0001 and would have to sell low at a market order sell where they could dump it at something like .00005.Only the brokers can trade on the 5th decimal.It's sort of like a dollar line instead of a dime line for sportsbooks.

Anyway,to make a long story short,everyone that followed penny stock got in on QBID about 4 years ago which was run by a bunch of gays.Everyone laughed at it and was embarrassed to own it but they bought it.The gays really hyped the stock and said that it would become a gay media empire.It went gangbusters and I panicked and sold it at 40 times what I paid for it and it went up a hell of allot more than that.

As with most penny stock,none of the hype developed and the company fizzled and it's back to .0001


Right after 9-11 risky and solid gold mining stocks that were joked about and laughed at were a good buy.Everyone knew that defense spending would go through the roof,the dollar would shrink,people were in fear,China and India were in need of more natural resources.Most people I know did well with the gold stocks.

Back in the early 90's I bought penny oil company stock when oil was $12 a barrel and a broker I knew made fun of me.Know one wanted to own tar baby oil stocks.All of a sudden oil goes gangbusters and the politicians are crying fowl that fat cats are making a profit.Where were these same politicians when no one wanted to buy oil stock and you were laughed at as an idiot that was going to lose their shirt for buying it.

[pico]

if you write a call during ex div date, the div actually goes to the option holder. the only difference that i can think of between the two is poxy voting. for the covered calls, i think the person holding the stocks gets to vote. other than that, a and b should be the same.

[Ganchrow]

Originally Posted by SBR_John

OK but something has to give. That July contract is already void of any premium. Expanding the premium could account for some of the closing of the spread but not .35 worth.

Even the July 35's are at par. Certainly the premium can not be expanded to cover the dividend in that contract.

I *think* the risk to the trade is in the opening. I know they are fairly priced. However, with American style contracts they can not go below the bid/ask or they will be exercised. The July 35's are bid 6.80/6.90 with the stock at 41.85. It is not adjusted for the dividend. Its simply a deep in the money call with 13 trading days left on a low beta stock.

I guess I'll short a few at the close tomorrow and see if it opens the ex-dividend session .35 lower, assuming there is a flat open. (watch it gap open down $2)

The standard option valuation model used in finance is known as the Black-Scholes pricing model. Black-Scholes tells us that several factors jointly effect the price of an option. They are:

1. the type of option (put or call)
2. the strike price of the option
3. the price of the underlying stock
4. the volatility of the underlying stock
5. the dividends that remain to be paid
6. the prevailing interest rate until expiry

Now let's look at the example you gave earlier:

Originally Posted by SBR_John

ATT is at 41.85. It goes ex dividend Thursday less .355. The July 40 calls trade at 1.90 on the bid.

You then go on to say:

Originally Posted by SBR_John

That July contract is already void of any premium.

But this is not true. Assuming the stock is about to go ex for 35.5¢, then there's 40.5¢ of premium built in (ignoring the bid-ask spread) after adjusting for the dividend. That premium represents the volatility of the stock that's expected to persist until the option's expiration on July 21st (the first Saturday following the third Friday of the month), corresponding to d & f above.

If the stock weren't about to go ex, then we'd expect to see the option trading approximately 35.5¢ higher. The option is not just going to gap down on tomorrow's open. Rather (all else being equal) the stock will gap down (due to the dividend), while the option will be essentially unchanged (in other words, about 40.5¢ higher than the strike price).

As Milton Friedman once famously said, "There's no such thing as a free lunch." This is certainly as true in options trading as it is in any other aspect of economics. Institutional and exchange traders are by and large pretty damn smart and pretty damn greedy people. There is no way in hell they would let you (or any other individual investor) scoop up a fairly riskless 35.5¢ per share in AT&T (an extremely heavily followed stock) when the money could just as easily go to pad their own pockets.

Listen, I'm certainly not telling you that you won't make money on this trade. You very well might. You might even make money the next ten times you make this trade. But what I am telling you, what I'm basically guaranteeing you, is that this does not represent a profitable long-term trading opportunity. The market is simply too smart and too technologically and mathematically savvy to allow so great an inefficiency to persist.

[Ganchrow]

Originally Posted by picoman

if you write a call during ex div date, the div actually goes to the option holder.

This is true when shorting a stock (the one borrowing the stock owes the lender value of all the dividends paid) but is not true when writing a call on the stock.

[SBR_John]

If the stock weren't about to go ex, then we'd expect to see the option trading approximately 35.5¢s; higher. The option is not just going to gap down on tomorrow's open. Rather (all else being equal) the stock will gap down (due to the dividend), while the option will be essentially unchanged (in other words, about 40.5¢s; higher than the strike price).

Thats why I went to the 35 as an example. There is no way that Call nearly 7 points in the money expands its premium and remains "essentially unchanged" while the stock drops by .35 on the open. Because if it did, I'd gladly take the other side and buy the stock and sell the call to capture that .35 for the 12 days left in the July.

[pico]

Originally Posted by Ganchrow

This is true when shorting a stock (the one borrowing the stock owes the lender value of all the dividends paid) but is not true when writing a call on the stock.

my points is that when you do a covered call, you lose the div even though you have the stocks.

[Ganchrow]

Originally Posted by SBR_John

Thats why I went to the 35 as an example. There is no way that Call nearly 7 points in the money expands its premium and remains "essentially unchanged" while the stock drops by .35 on the open. Because if it did, I'd gladly take the other side and buy the stock and sell the call to capture that .35 for the 12 days left in the July.

The existence of dividends will sometimes (in cases of one or more of: very large dividends; very short times to expiry; very low volatility; or a very deep-in-the money option) make it optimal to exercise a call option early (immediately prior to the ex-dividend date). What you'd find in a situation such as this would be that if you had written the call prior to the ex-div date your position would be exercised against you so you would no longer have the short position when the ex-div date arrived.

If this is not the case in this instance, then I'm sure if you were to plug in the numbers to a Black-Scholes calculator it would all work out correctly.

No such thing as a free lunch.

[Ganchrow]

Originally Posted by picoman

my points is that when you do a covered call, you lose the div even though you have the stocks.

As long as the existence of the dividend does not make it optimal for the call holder to exercise early, then this is of no importance with respect to put/call parity.

[ShamsWoof10]

Excuse me for interrupting the debate boys but Ganch. BC, JC, you guys seem sharp and I wouldn't mind having your opinion and anyone who has been watching Uranium for the last 5 years... For a long while it went almost straight up... I mean the chart looks like the Eiffel Tower but it has pulled back some recently and I like it to start moving back up but would like to hear what you have to say about it...

[jumper]

consider getting your fix at bullionvault.com

[SBR_John]

We have a Bingo! The calls, the July 35’s, would certainly be exercised. I used to lnow that. They would simply because the dividend is larger than the premium. But…(theres a free lunch out there some-frigging-where! And im going to find it! )… With all those in-the money calls being exercised how does the stock open even?

In the T example, there are over 50,000 in the money calls with less premium than the dividend. These floor traders need to dump the stock or they risk a move that eats up their .35. I would think they would be sellers at the open. Black-Scholes may be exact, although it is not in part because the volatility measure is trailing, but is it possible to pressure the stock and somewhat know in advance that a stock could open lower on ex day due to the amount of in the money calls being unwound?

[ShamsWoof10]

I am with you on the gold and silver deal and taking delivery is the way to go no doubt.. WBuffett had a lot of it and took deliever of all of it if memory serves... Like I said that's fine but I want to play some too....

[JC]

If you are long calls and the stock is going ex-dividend, you have to look at where the puts are trading to decide whether or not you will exercise the calls.

When you exercise calls, you are doing two things,selling the call and buying the stock. As we discussed earlier, that is synthetically selling the put. You are effectively selling the synthetic put for the amount of the dividend. If the puts are bid higher, don't exercise, it's better to sell the puts. If the puts are offered lower, exercise, and buy the puts or exercise only.

There are other reasons to exercise that come into play if it is a close call. If the stock is hard to borrow, you will be more inclined to exercise to get long stock.

[pico]

i swear John has asked this exact same question before about the options and the ex divs and ganchrow gave some kind of explaination and end it with "there is no free lunch". deja vu.

[jjgold]

The floor traders love the public and make their living off them period whether in the options market or equities market.

[SBR_John]

Thanks for the feed back on that JC and Ganch!