This page has been archived and commenting is disabled.
Guest Post: Learning How Theta Can Be Utilized to Trade Gold
Submitted by Chris Vermeulen of The Gold and Oil Guy
A fundamental knowledge of Theta is imperative in order to understand the mechanics and construction of option strategies. In many cases, Theta is either the profit engine or the means by which experienced option traders reduce the cost of opening a new position. Theta can even take an ETF that pays no dividend and create a monthly income stream utilizing a technique known as a covered call write.
The most exciting thing about options is their versatility. You can trade them in so many different ways. A trader can define a positions’ risk with unbelievable precision. When traded properly utilizing hard stops, options offer traders opportunities that stocks and futures simply cannot provide. Theta allows option traders to write spreads which generally offer nice returns with very limited risk.
Theta is the fundamental reason behind the slow and relentless deterioration of option values over time. As a series of options gets closer to expiration, Theta becomes a very powerful force. As stated in the previous article, the final two weeks of option expiration put Theta into overdrive. Courtesy of Optionsuniversity, the two charts listed below illustrate the rapid decay of Theta.
These charts illustrate effectively that option contracts which are out of the money and consist entirely of time premium decline rapidly in value on their way to 0 potentially. While Theta must be respected, it is Theta’s relationship with implied volatility that really makes it a force that must be monitored closely.
While I will not discuss implied volatility in this article, in future articles it will gain considerable attention. Implied volatility is paramount in every decision that an option trader makes. Ignoring implied volatility and Theta is a recipe for disaster, the kind of disaster where an entire trading account is wiped out in less than 30 days. In most of the trades that I place, Theta is regularly a profit engine. I never purchase options naked, in every option trade that I construct I am utilizing some form of a spread in order to mitigate the ever present wasting away of time premium. In many cases, Theta is the driving force behind my profitability.
In any other case, Theta decreases the cost for me to purchase options allowing me to minimize my risk to an acceptable level. Vertical spreads come in two variations: debit spreads and credit spreads. A vertical spread is a multi-legged option trade which involves more than one strike price. As an example, we will assume that GLD is trading around $119/share. If I were to have placed a call credit spread trade at the close on Thursday I could have sold the GLD August 120 call strike and purchased the GLD August 121 call strike, thus receiving a credit in my account.
At current prices as I type, the August 120 call strike would have resulted in a credit to my trading account of $53 dollars while the August 121 call strike would have resulted in a debit in my account of $29 dollars with a one lot position size. If I were to place this trade, I would have a strong feeling that the price of GLD was going to decline. The reason this trade is called a vertical credit spread is because the total trade results in a credit to my account of $24 dollars less commissions. The vertical aspect of the trade is based on the arrangement of the positions on the options board, also called an option chain.
When an option trader places a credit spread, they are relying on time decay, Theta, to provide them with profits. In many cases, option traders will utilize vertical spreads to play a directional bias. In the example above, the bias on GLD would be to the downside. However, the maximum amount I can lose is limited because I purchased the 121 call. The most I can lose is $100 dollars minus the credit of $24 dollars. Thus, the worst case scenario for this call credit spread would be a loss of $76 dollars for every contract I had put on. If I had put on 5 contracts, my loss would have been limited to $380 dollars plus commissions.
A call debit spread is constructed exactly the opposite direction. If I believed that gold was going to increase in value I could buy 1 August 120 GLD call for $53 dollars and sell 1 August GLD 121 call for $29 dollars. Notice that the sale of the GLD 121 call reduces the cost of the GLD 120 call. By selling the GLD 121 call, I reduce the cost of this spread down to $26 dollars. However, my maximum gain is limited to $74 dollars minus commissions. The point of this illustration is more to focus on the way Theta helps option traders in practical situations.
When an option trader utilizes a credit spread, Theta operates as the profit engine. When an option trader does the exact opposite by placing a debit spread, Theta acts to reduce the overall cost of the spread reducing the overall risk exposure. As one can see, understanding Theta is crucial when trading options. While vertical spreads are very basic, they can provide nice returns while having the unique ability to control risk with an extremely tight leash.
In future articles, we will dissect the various option trading strategies which option traders can utilize in different situations, at different points within the option expiration cycle. While this article will conclude the basic overview of Theta, future articles will discuss intimately the key relationship that Theta and implied volatility share. In closing, I will leave you with the famous muse of Benjamin Franklin, “Time is money.”
Get our Free Weekly Options Education Articles and Options Trading Signals by joining out free newsletter at www.OptionsTradingSignals.com
Chris Vermeulen – Gold Analyst/Trader
J.W Jones – Independent Options Trader
»
- 9079 reads
- Printer-friendly version
- Send to friend
- advertisements -
Selling PUTs works too...
Just ask WEB at BRK...
There are no limits in gold futures.
So on Monday if gold opened $400 higher because of (x), my risk is limited? What is the point, its hedging at best, and why hedge the trade by selling your reward. It just seems like diminishing returns and it washes out.
In this example, no matter how high GLD goes, you can deliver at $121.....
Maximum Daily Price Fluctuation
Initial price limit, based upon the preceding day's settlement price, is $75.00 per ounce. Two minutes after either of the two most active months trades at the limit, trades in all months of futures and options will cease for a 15-minute period. Trading will also cease if either of the two active months is bid at the upper limit or offered at the lower limit for two minutes without trading. Trading will not cease if the limit is reached during the final 20 minutes of a day's trading. If the limit is reached during the final half hour of trading, trading will resume no later than 10 minutes before the normal closing time. When trading resumes after a cessation of trading, the price limits will be expanded by increments of 100%.
Thanks, that is a huge difference. I was also confusing futures trading with etf trading, not the same thing. Even if there is a limit up move in gold over and over, the etf will still be trade open, so there is less risk.
Very Good. I'm a little slow and still got it. I better stick to bullion. I interviewed an interesting gal Abigail Doolittle last week for about 18 minutes. She had some things to day about gold. "Gold will be the ultimate king." Listen to the interview: http://thevictoryreport.org/2010/08/09/abigail-doolittle-8-9-10-deflatio...
Hey, thanks! My American Gold and Silver Eagles thank you.
For what? The reminder that I'm doing the right thing by NOT using these magnificent tools to piddle in the Ponzi. I hope others here get a lot of useful information for their trading. I'll pass.
Rocky, I finally realised the narrowing spread of gold bullion and collector coins, Im now buying more mid and high grade US pre 33 gold instead of just bullion. If things go well, the collector market will improve and my investment will hold more price in frn's. If/when things go bad, I still have more gold, a win win for me.
Be sure you get NGC or PCGS slabs. Any other grading service is not as accepted. You should not pay much more of a premium for the slab these days.
to all gold bugs. Adrian Douglas has a great article on gold suppression at goldseek.com titled "gold not "fixed" but rigged.
Have a happy day.
Rocky and merehuman,
+++++ I do not know anything else than other observers. But, I still want more gold ASAP!
It ain't just bling when the market starts to swing.
still on my list..fertilizer, candles, oil and oil lamp and more seeds.
The expanded garden(took out a driveway) is doing fine, made a lot of mistakes and glad of it as next year i will do better.
It may be that silver and gold will be useless as tits on a bull for a couple of years. hard to see the future but food will be needed and wanted by all.
Never took survivalism serious all the many years folks claimed the end was nigh. This time is different.
OTOH Great time to learn to love your neighbor or move!
Adrian Douglas does a great job explaining the manipulation that is NOT obvious to most of us. Gata.org has a link to it also
Yes, every time the market does not go in the direction that you or somebody else thinks it should, it is rigged.
You are never wrong, it's just that "people" "manipulate" the market.
Bravo, check article above by Adrian. Lays out the sheme in detail. Now gold will really jump. I thought you said you quit? Dont quit posting, you are a source of humor for many of us oldtimers.
I said I would quit bashing the goldbugs.
I didn't say that I would quit bashing ridiculous conspiracy theories with no merit.
I wrote about this strategy a few months ago in some comments to a previous post concerning the GLD ETF.
Buying bullion and then shorting call GLD call options is a perfect strategy to gain income and hedge gold volatility. And if the GLD haters on this website are correct and the GLD is a sham, then you will make money on both sides of the trade when the GLD implodes.
The funny thing is that most of the re-re's that comment here couldn't figure out the strategy that I was explaining. I doubt they will understand this post either.
Maybe it's a Sicilian thing but I came to the conclusion that buying physical and shorting the GLD was the perfect covered call. My gold pays a dividend and fif the GLD underperfomrs actual gold prices, which I think it has to, then I win twice. Gumbas unite.
Thanks ATM. Glad there are people on this site that can understand basic and profitable trading strategies.
Very nice trade, keep rolling the calls.
I'm with Rocky on this; the whole point of bullion is to escape the paper Ponzi game. I am also annoyed that the whole premise of this post is to expand the financial engineering using elaborate layered/paired paper positions to scalp the market. Just like in the gold stocks, constant pumping/dumping by the cartel robs the long term investors who would like to participate in the coming runup in gold, but their emotions get to them when they see their positions get drawn down by the (now every monthly) cartel actions to burn the hedge funds using leverage on gold futures and options. Where do these bandits think the money is coming from that they rake out of the market on a monthly basis?
You either don't understand the post or don't understand basic economics. If someone wants to buy an option on gold, then someone has to be willing to sell them that option. It's that simple.
So writing covered calls is providing liquidity to the gold options market and ALLOWING people to invest in gold call options more easily.
Right, sort of like opening up a second enterance into a concentration camp. The more market participants they get in, the more gold fillings they confiscate.
Buying or selling options in the gold market is not the best use of one's time and money. They are slammed down every month so that they expire worthless. I guess by writing options, you are putting on a Nazi uniform in the metaphore mentioned above, but I feel that that is probably immoral. Of course, I would rather be writing the options than buying them, just like I would rather be a guard than a prisoner, but given the choice, I would rather be one of the Americans coming to liberate the camps, by owning physical.
Excellent metaphor, gotta remember that one.
Congratulations on your grasp of the big picture.
That doesn't make any sense - where do the people on this website learn about financial markets?
How can most options expire worthless? Exactly 50% of options expire worthless - always. For every call option that is worthless, there is a put option that is in the money and vice-versa.
And if you are saying that "call" options mostly expire worthless, then you are saying that you don't think gold prices will ever go up. Bizarre reasoning.
Look, I don't get the Nazi references to the option market. People are free to buy/sell/not participate in any market they see fit. If I want to create an income stream by writing covered call options, I don't get how that is any skin off someone else's back.
If you truly believe gold is undervalued and headed higher, then you should be buying the options that I am selling and then you can force me to pay out at maturity.
"where do the people on this website learn about financial markets?"
Random conspiracy theories from David Rosenberg? The prize in a cracker jack box? Fox News? Hallucinogenic drugs?
"And if you are saying that "call" options mostly expire worthless, then you are saying that you don't think gold prices will ever go up."
Of course they can't. They're manipulated by "people" who want people to sell their gold so "they" can have all the gold. Also, I am paid eight million dollars a year to post anti-gold rhetoric on zerohedge to help this end.
"Look, I don't get the Nazi references to the option market."
See the first quote I answered. And the second.
"If you truly believe gold is undervalued and headed higher"
then buy physical at the highest prices possible, and hold and pray until it gets to 54000 an ounce, which it will do next week when the United States becomes Zimbabwe.
people manipulate gold" No , Banksters manipulate gold. Not sure if they qualify as people.
They sure do a good job at manipulating it too, don't they?
That's why it's up 5X.
At the money calls and puts expire worthless.
http://www.optionetics.com/market/articles/13857
Options a zero-sum casino con game for suckers.
Option mania peaks before market crashes.
If gold gaps up or down $100, a lot of call and put sellers/writers may rue it.
The income stream covers risk until option writers ruined...
At the money is literally one penny - I would love to see how many options actually expire at the exact strike price (maybe one in a thousand?). Besides, that would be the best possible option for an option writer.
Also, I would love to see how it is possible to be ruined with a covered call. Do you know what this phrase means?
Oh I think I understand economics pretty well. Your premise is that these financial derivative instruments allow the private investor (sic?) to play both sides of a trade, and 'make' money without doing any work by correctly matching his book to the spread. This is surely the pinnacle of capital investing. Vermeulen's objective in making this post can only be 1) to expand the population of rentiers who know how to game the system using these derivatives, or 2)attract a new batch of (suckers?) investors to participate in this new form of the Ponzi, or 3)talk his book, which is basically an ad to sell advice as to how to become one of these new rentiers. I guess in a sideways market, seeking alpha is dead.
My original objection remains: the whole point of bullion is to escape the paper Ponzi game.
Bingo:
Three Card Monte.
You can use the option premium that you receive to buy more bullion (or anything else you would like to buy) since there is no cash maintenance requirement.
So you can't dismiss this trading strategy by likening it to the paper Ponzi game since you can use the proceeds to increase your physical holdings.
I'm going to be very unpopular here and say the following:
Straddles, Strangles, Theta... seriously, grow a pair and have an edge when trading so you can buy premium in puts or calls and make money. I'm advocating market timing, aren't I.
Junk away.
Buy low volatility, sell high volatility.
Currently puts have relatively low volatility.
Perhaps not later this week...
The leverage of options is like crack cocaine. Enjoy responsibly.
Writing covered calls is not leverage but rather a hedging trade. So it actually reduces rather than increases risk.
And increases your income too.
Hedging income = premium received.
Underlying moves beyond that,
and up the lazy river without a paddle...
That is why you set the strike price way up above the current spot. I always give myself 15-20% cushion on 3 month rolls.
Even if each option ends up in the money - I am up at least 60% per annum. I will take that with any investment any year.
In reality, I have only had to pay up on one option roll (out of 15 or so) - and I made it up on the next roll.
I do understand ZH's desire to give idea and thanks to the author for the article.
but.....
Theta!
Listen up - I postulate that when the financial world caves in and you are the last person in the house your strategy may be missing something .
I believe that if it doesn't drop on my foot it isn't safe.
Ther strategy needs one thing - a counterparty(s)
Does it occur to anyone that vaporware is still vaporware.
Monetary, financial, and stock trickery is what hammered your portfolios last time.
God speed though - you'll need it.
Your point is well taken, but I'd rather hold it in my hand than drop it on my foot, as a big bar will amputate your toes if you drop it on your foot :)
If it doesn't hurt when I drop on my foot I won't buy it.
as a professional option trader for 20 years let me just say this ... if you have no view on the vol (and remember, options traders first and foremost trade vega) then you shouldn't trade an option. If you are using options to give you a lazy stop then you probably will pay away a lot of money for no real reason.
You are often better off just buying or selling a little bit of the underlying delta and running that. I've seen plenty of "smart guys" buying options at the wrong level of vol only to see the underlying move their way and they've ended up making next to no money cause the paid too much for the vol initially (ie they paid up for the skew of the initially outstrike option, only to see if collapse when it travels to be at the money).
That's not to say you can't make money from option trading - you definitely can... just be away of all the components that you are trading when you buy/sell one!
Of course , the biggest concern with gold right now is that goldman are bullish on it ... urghhh......
Good luck!
That must be why the price of the underlying goes down and the price of the put I bought to protect said underlying...goes down too.
Can anyone who buys physical answer this: Theoretically if you had ~120k to put to work in gold why would you buy at a bullion broker with a 10% markup when you could buy a Nymex contract and take delivery? Just curious.
The CME contract spec http://www.cmegroup.com/trading/metals/precious/gold_contract_specificat...
Not everyone can drive to comex and back up to the loading dock. There are people who are doing it however. Of course, you are betting on them having it. So far, so good.
Didn't the COMEX change their definition of physical to include GLD along with bullion?
Gamma, good question. Several possible answers:
-Investing 120 K gives you better pricing then 10% markup.
-If you want smaller pieces, coins will do; but you have to pay the minting. In case of bars the markup is way smaller; at one bullion dealer I know http://westgold.de/html/prizeList.php the buy-sell-spread for kilo bars is 2%; the mark-up to spot is even smaller.
To Comex:
This guy at http://harveyorgan.blogspot.com/ tracks delivery numbers and it looks like delivery is delayed. Moreover, the real physical market must be elsewhere. Yearly mining output is around 2400 tons and there are some 250 trading days. So, every trading day a little less then ten tons of gold are delivered somewhere daily.
From Harvey Organ's blog: “Thus the total gold standing for August is as follows: 630,900 oz (already served) + 101,200 0z (to be served) + 90,000 oz (options exercised last month) = 822,100 oz of gold or 25.61 tonnes of gold. We lost .3 tonnes with the contraction of 103 contracts.” That is a bit over a ton for a trading day in a delivery month.
I hope that answers your question.
I'd put my money on crack as the culprit.
"As stated in the previous article..."
A link to this article would have been considerate.
indeed
Tyler, got link?
Have to be honest about this,sometimes I trade these option to.Sometime te market is so
extremly oversold or overbought I have to get in.Last time for me was 10 march 2009,put A
little money in and made some nice profits and bought as much gold and silver as I could.I
have been out for a year or so.Waiting for dow/gold ratio to hit about 1/1 then I will try to pick
up the pearls.Nice house by then will be affordebel priced in gold I think.We goldbugs will do
just fine.
100%gold,silver bullion,coins,jewellery
Sell corn - buy gold -screw the paper.
Let's face it. The whole purpose of this article is to stir up discussion by bringing in Johnny Bravo. Put "GOLD" in the article title and he's here, unless he is out delivering pizzas or mowing the grass for his Mom to pay rent for living in her basement. He doubles the number of comments (at least). Very few of the ZH readers will jump right on this "trade" idea. And for those of you who disagree, you are one of the few.
First, I don't deliver pizzas, or live with my mom.
Second, I'm done trying to convince people that can't be convinced. There's nothing productive involved in telling people that they are about to lose money.
You can lose your money and I don't care anymore. That is all.
so you got fired and your mom is pissed and kicked you out of the basement.
Sleeping bag is a home of sorts and one meal per day should be enuff.
Glad you figured you are beating a dead horse.
I haven't lived with my parents since I was 15, thanks.
Also, I make enough money trading to not work, although I am currently seeking work as an accountant, to get enough hours to get my CPA license.
The only reason it's a dead horse is because nobody listens, not because it isn't true.
Thanks for being an all around asshole with your comments though.
Does that mean you are going away, like Cheeky? I'll miss Cheeky, but not you.
Lol Thanks Rocky. Having a funny day. Do have a read of adrians article, its well worth it.
Retarded people of a feather stick together!
No way. Every time I need a laugh, all I have to do is come and read about the "conspiracy" theories and "manipulation" in the financial markets.
I'll stop posting negative things about gold. What is about to happen to the price of gold is negative enough.
Thanks. I always wanted somebody who can't spell raccoon to not miss me. It shows that I don't co-mingle well with the retarded.
We've covered the "raccoon" thing before. Or are you too stupid to recall that it was done on purpose?
RR no point in bringing him up if you have such a beef.
BTW, this is less of a trade idea thread than a post on one of the most important Greeks; nice to see some intro stuff re options here.
Agreed. These people are like, obsessed with me or something...
You'd figure that they'd welcome my calls, since they are usually correct.
I guess that they'd rather lose their asses and claim "manipulation" when the markets don't go as they think they should.
Oh well, not my problem.
I thought you were going away...
And like your usual thoughts, you were wrong again.
Could you put these two trades on with "European options"? If they were "American options" couldn't you get exercised on your buys and still be on the hook for your sells?
Or maybe I should just stick with what I know well, which is not paired option strategies?
Index options are EU, most others are American though.
Since its a covered (hedged) call, it wouldnt matter if you get exercised as your loss is limited.
GLD options are american, if you are short then yes you can get exercised - but in theory its highly unlikely as GLD doesn't pay dividends, and in fact being exercised would probably make you a windfall profit as long as you can settle in cash.
A decent option selling strategy usually deals with options out of the money so you won't get exercised anyway.
All in all a good question, the devil is in the details but I think you're ok.
Thanks to both of you for responding. Happy hunting...
Updated DOW and SP500 charts:
http://stockmarket618.wordpress.com
You could also make arguments that the charts show a falling wedge or a bull flag as well.
I think that the chart is pretty similar to 2004, honestly.
Then again, I do see a downtrend as possible as well.
...la, la, la... I can't hear you.
You don't have to be able to hear to READ my posts, which you proved by posting more retarded drivel beneath my posts.
Gold is not an investment,it's saving in sound money.
It could be seen as the ultimate disinvesment.
Do not want to squander to much of my money in the
big casino.Could be a good idear to short gold a little after a big run up
or go long after a big drop when you have a nice stash,but I would
still be transfering the paper profits for real gold.
i personally love the beauty of the naked put sell, and if exercised, the covered call.
the put - "pay me to be able to sell your stock to me at a lower price than now, but if the price stays flat or goes up, i keep the change (80%).
the call - if the stock is put to me, then you can pay me to sell it to you at a higher price. if it stays flat or less, i keep the change. and any dividend. and the higher price.
this one-two premium punch can reduce purchase price risk by 10-15% easily.
if few exercises take place, returns can be easily 25% plus with nominal risk.
if your potential exercise are backed by t-bills rather than margin, this is pretty conservative.
Hogwash.
Most option market makers/traders go out of business...
Rather than throwing out (up) these random "facts", can you please provide some evidence that most option market makers go out of business.
You should be able to give us a list of 20 or 30 right off the research piece that you got this information from.
don't know about most, but i've got three years of easy profits (2008 the easiest). and my returns have surpassed the 25% i conservatively posted. don't forget, i am selling a wasting asset to someone who is buying a wasting asset. i don't trade them, i let them expire worthless, or get exercised.
Some good minds at work here, including the article. Theta is the driver behind many solid option strategies, but the largest component of theta is usually interest rate. With short rates lower than a snake's navel, many classic plays, like a long butterfly spread, are less profitable. In fact, low volatility and high interest rates are the golden zone for theta, the opposite of what we have now.
That said, options are one of the few areas that consistently reward patience, knowledge, and persistence. Hail and well met.
Resources like the one you mentioned here will be very useful for me! I like to share it with all my friends and hope they will definitely like it.
virtual server hosting
windows 2008 vps hosting
mssql hosting
windows vps server