I hope you are not getting bored with these option scenarios but here is another one. This is called a ratio spread. I have been hammering my brain trying to devise the most leverage to take advantage of a high probability move in our underlying beloved AGNC.
We all know with a high degree of certainty( although we all know this game is not 100%) that Agnc will historically bounce back about 1.50 within 10 days of the offer...caveat- when the offer is post EX, or pre EX by at least 12 trading days. If offer is less than 7 days pre EX I would hesitate with the following trade.
Sell(short) 1 Deep ITM call and buy(long) as many ATM or slightly ITM calls as the short call's premium allows. Example : let's use Sept30calls as a proxy for the ATM price of the PPS at offer. Sell Sept28calls at 2.20 bid and buy 3 Sept30calls at .75 ask. This cost you .05 or pretty close to zero for outlay.
PPS moves up by 2.00. The 28 call is now worth the same as our proxy Sept 26call or 4.40 ask to buy it back and the 30's are worth the Sept28 price of 2.20 bid. So your net profit is (2.20x3)-4.40 or 2.20-.05(cost) or 2.15.
If you had bought the Sept30's outright at offer they would have cost you .75 and you could sell them for 2.20 for a 1.45 profit. So by putting on this ratio spread you have essentially increased your leverage from 1.45 to 2.15 or almost 1.5 times.
Downside, the PPS stays the same after offer or goes down. Aaahhh, do we believe that will happen? ;-)
Hey Doc - you're kidding right? How could someone get bored with your posts! I greatly appreciate them and have gleaned a lot from them.
My call is this:
1. AGNC reports record earnings at the next shareholder's meeting.
The share price has been moving higher than historically. So others are suspecting the same.
2. They've been putting the money from the previous spo's to work in a perfect enviroment for their model. Maybe they even increase the dividend .05 to sweeten the pot and have more support for their request to increase shares.
3. Last quarter before the ex-div the stock closed at $30.65, well heck we're almost there now at $30.35 a full month before the divvy!
So it only makes sense that if record earnings are announced with or without a higher divvy, the stock goes to a record high on the day before the next ex-dividend. At this momentum, I approximate $31.50 to $32.
AGNC is well hedged and according the exec's it would take a 200 basis move to even begin affecting the bottom line. This is not happening anytime soon or overnight in my opinion.
all the best and always enjoy communicating with you.
"I hope you are not getting bored with these option scenarios but here is another one. This is called a ratio spread. I have been hammering my brain trying to devise the most leverage to take advantage of a high probability move in our underlying beloved AGNC."
The most leverage is to time the event and take a single position going into it which you reverse to the opposite position coming out of it. Any combination of positions at one time doesn't increase leverage of a certain event so much as hedge your uncertainty about it.
"The most leverage is to time the event and take a single position going into it which you reverse to the opposite position coming out of it."
That is exactly what this post is about....entering the strategy at the spo.
"Any combination of positions at one time doesn't increase leverage of a certain event so much as hedge your uncertainty about it."
I agree about hedging to the downside, which the concern of others was about if you were following the thread. By definition an option is a leveraged position. With the ratio it is simply both a downside hedge and a leveraged upside position for limited movements in PPS.
You are right about getting maximum leverage by not involving the short call if the price moves dramatically in your direction. If the PPS goes to 40 you would have been better off just buying 3 calls without the short call.
By being a "RATIO" it allows much more leverage if the stock moves in the expected direction and amount (by 2.00). I am not touting this particular strategy so much as offering it as one of many..hence the title "Option 3".
Re-read the example as if you bought 3 sept30calls instead of the ratio spread and the stock moves to 32. Leverage.
Interesting to read. I think as always if we were sitting in a room and the benefit of a full conversation instead of message board responses we might be able to understand what we are all trying to articulate.
I think Terr has a point, a very good point. Unfortunately, even given the one way trading that I do, I am afraid that plunging into a downward cycle on calls is very unpleasant, producing what Doc describes as intense fear, lack of conviction, etc. When I enter into a call trade, I know that I will suffer paper losses just from the spread and most certainly from a reduction in the share price. so, I just live with that and buy in tranches now to average down the call price. That works every time.
Any call trade requires conviction on the upward price point at ex-div, and Terr and I are sharing the same fear, which is, "what happens when rates rise". Having trade it many, many times, I have made plenty over a long period of time, and it should be noted that AGNC performed very well, as did the other MREITs, in 2007, 2008 and 2009, AGNC has done well and I have made more money from this stock/calls then any other. So, we should be weary of, but not fearful, of the rate increase fear. The bottom line is the cost of funds are fine, as are repo rates. Mortage yields will be okay, unless the treasury just dumps the entire lot on the market, which they will not do. They also like the interest payments.
So, where does that leave us? Different concerns, different styles, and useful dialouge.
The "honey, bad mood factor" can run big at times, but my wife and I watched the Tsunami kill our value in five minutes. Can you imagine the conversation, when I said it would all come back? It did, but I had too much cash in the game to make the kind of money I wanted. She was observing my trading and she said, "why don't you take your profits and wait for it return". This was an MLP, ETP. I said, "let's try". It worked and I did it three times in one week.
I will not sell a call on a high dividend share until the time comes for me to realize my expection or ex-div. I have learned this lesson so many times that it is part of each call trade. You just have to live with the ugly to have the profit.
I just can't get my head running in too many directions, and I have adopted a new model of value call trading, whereby, I want to make my mark with lower prices. This is something Taymere has been on about before, and he has been right. So, I am waiting for the moment when all the market dumps. It will happen, and I will make more money doing that than trying to create some action.
At this junction, the trade is HTS, as once again, we see reluctant to be buying up AGNC over $30.50 at this point. It will happen again, but I think the move from $29.20+/- to $30.50 for HTS (13% yield) is more likely than AGNC moving from here to $31.00 (18% yield).
Anyway, just my trading plan. DOC, go for it. If it doesn't work out, let us know. If it works out, great. Either way, we are doing what we need to do, which is communicate.
New with AGNC.
What do you guys think of selling JUL deep ITM covered calls (28s) to hedge against ex-DIV drop, assuming ex-DIV date is end of June. And buy back the calls after SPO but before JUL options expiration.
With this strategy you get to keep your shares, get the dividend and protect against the inevitable drop in PPS post ex-DIV and SPO. Am I missing something?
"With this strategy you get to keep your shares, get the dividend and protect against the inevitable drop in PPS post ex-DIV and SPO. Am I missing something? "
Yes! With that strategy you lose your shares and therefore do not get the dividend.
Think about it. If you were the buyer of your short(sold) call at 28 wouldn't you say on the day before EX DIV , "I can exercise my call AND collect the dividend on my shares and if the PPS recovers quickly post EX, which it has in recent quarters(sans spo), I can sell my shares for more than the divi drop."
Example: the day B4 EX PPS at 31, long 28 call holder exercises and is debited 100 shares @ 28. Collects divi for $140/contract. PPS bounces from 29.60 to 30.00. Sells his shares at 30.00 and collects difference in share price of 2.00(31-28). Ends up net 3.40, and does not suffer further decline in PPS post EX.
In other words, your shares will be called away on the EX date and you will not be entitled to the divi.
Appreciate these ideas. I am just too simple and one way focused. What I have been doing is holding onto cash and waiting for a serious event. It takes patience, but had I been in cash on the day of the tsnumai, well I would have made so much in one week I could have stopped trading for the year. I am picking my shots carefully now, as I am working and can't watch the Market. However, I have been a trading less with more accuracy, particularly with one or two day trades with the mlps. Agnc and the merits just aren't that volitile unless there is big downside event.
If I could offer you a few ideas. I don't think Agnc options offer as much liquidity and the type of strategies you are considering may work better on thinner spreads in large cap players, like apple to name one. The spreads are wide for Agnc in the near term. Your model has to take into account bid/ask spreads and decay under your scenarios. I think Agnc is best to trade for upside. If you need to sell calls or puts to generate cash for call buying, it seems the leverage will ultimately bite. Maybe not, but just my view.
My concern is for the downside, and it applies equally to this strategy as the simple bought call strategy.The last quarters have seen steady gains in bookPS and PPS. It has been so easy to play long that even I, a neophyte, made a good return. The problem is that eventually interest rate fears and reality will cause erosion of book, dividends, and PPS. It will be easy to be caught long in calls.
So my question is in what way could you give up some of the leverage profit to produce a breakeven or close to breakeven exit strategy if PPS does not recover? This question applies to the simple long calls as well as this.
To see the effects of this fear, just look at the performance of all the reits post the Q1 SPO's. They recovered then tanked only to be saved by a mind set change that took hold on April 12. (The only thing I could find to produce this mindset change was an article proclaiming the benefits of MREITS than ran in several real estate journals). Has this mindset been reinforced with some interest rate rumblings from the fed instead, I don't think we would have had the stamina for a full pre-exdiv run. So we longs dodged a bullet this quarter, but will not be so lucky eventually.
Hey (Sir) Doc,
Bored? Are you kidding? Your scenarios are never boring, and always educational. This may be my favorite one yet. As you have already stated, this is a play to increase leverage upward. I'm presuming that the sold call is covered, otherwise you need to go to the market for shares in order to settle up if assigned. This is more of a capital requirement than price exposure. I like the "protection" provided by the 30s, as they mitigate your exposure on the 28. If pps falls though the floor, I agree with your assessment that .05/share is the limit of your exposure, presuming the proxies are accurate. .05 is a small price to pay for increased leverage with no further downside. Unless I'm missing something (always possible), this looks like a winner to me.
Thanks again for the dinner in LA on Friday. It was great catching up and talking "shop".
Good Morning Jim,
I really enjoyed the visit last Friday. I am sitting down at John Wayne, waiting for the ride home.
Regarding this trade you are protected to the upside because of the leverage, so if AGNC goes to 40(taymere and rim drool) , your 28 is worth 12.00 and your 30's are worth 10 each or 30 , whoohoooo!
Your risk is limited to paying the owner of the sold call at expiration the value of the short call less the value of your long calls. So if the PPS ends up where it started(30), his short call is worth 2.00, and your long 30 calls are worth zero. So you will be assigned short shares in your account times number of contracts times 100 @ 28.00. So you are short 28 @ PPS of 30, so your risk is 2.00 max . BE is at 31 when your 3, 30's are worth 3.00 and the sold 28 is worth the same. After 31 it's gravy.
Hope that makes sense. Always great hanging out with my friend Jim especially with palm trees and warm weather!!