rawraw, how has your experience been with Lending Club? Some of those rates seem pretty good, and with these weird p2p things, I would be interested in learning more to see if there is a risk disconnect compared to other markets.
People seem to be borrowing money for weird things though… Seems like a bunch of people are borrowing at 21% to build swimming pools or to have cosmetic surgery done. Is this what “normal” people do with their money?
Perhaps this should be in a new thread.
Exactly, this is the key - once you’ve accepted the initial risk of choosing a limit order price, there’s no incremental risk (only gains) to selling an option instead of using a limit order. Yes, there’s a risk in choosing where to place limits.
Assuming trading costs < call premium you might come out ahead
that makes it clearer to me. Thanks.
I am still a little hazy on how one decides how many contracts to write. If you are rebalancing, it isn’t the full exposure. And a month from now, when these things expire, your rebalance requirements are going to be different (though possibly not by much, maybe that’s the underlying assumption).
You just write however many contracts is the same notional as your prospective limit order. If you’re planning to sell 100 shares of SPY at 170, you write one SPY 170 call instead of posting a limit order. Is that what you’re asking or am I not understanding? As you can see if you want to rebalance by selling 1% of your total portfolio equity exposure, the premium you’d collect by selling options on that size is an extremely small % of your total portfolio.
True, if the strike is hit before expiration and you want it to act exactly as a limit if touched order you’d have to trade the position delta neutral once it hits the strike (0 delta if closing a position or maintain a certain delta if you’re initiating) until expiry which incurs rebalancing costs. It’s impractical to do that, and would certainly outweigh any benefit from selling the option in the first place. And as you point out, given the size we’re talking about, it’s largely irrelevant.
Practically, if waiting until the nearest expiration doesn’t fit with your view you’d just post the limit order, but I can’t see too many cases where that’s a problem.
When you rebalance, all the assets in your portfolio have a certain value, so you say “I’m going to sell x dollars of ABC and buy y dollars of XYZ and z dollars of JKM, because my portfolio weights are off of their target weights.” And with that information, you get a notional number of shares, which you can divide by 100 (for example) to get the number of option contracts.
But you don’t actually sell until you get assigned or the option expires, unless you want to have a naked call option out there, so where is the money to buy XYZ and JKM coming from? If you wait until expiration, your portfolio may have different actual and target portfolio weights than when you wrote the options, and so now you need to rebalance with a different number of shares than you have options on (maybe this difference is minimal, which it might be if there are just a few assets in the portfolio).
Alternately, you could get an option that expires very quickly, but then there isn’t much time premium left, and transaction costs are likely to be substantial in comparison to the premium.
So while I get the idea of making money off of covered calls versus limit orders (which do have potential upside if the limit order delivers a more favorable price), I don’t see how this works well as a rebalancing technique, unless you have a portfolio that changes slowly (and those rebalances are likely to be tiny anyway).
In other words, it may be interesting to try, but it may be sufficiently complex and full of transaction costs that it isn’t worth the trouble. Usually, when you rebalance, you want to rebalance today, not rebalance a month from now with target allocations you determine today.
I’m not sure I understand your rebalancing scenario, so I’ll try to reframe the problem.
The most simple way to look at the issue is this: If you have a stock trading at 100 and you have a model that shows FV is 95, would you rather post a limit buy order at 95 or sell a 95 put and wait for assignment?
All synthetic equivalents hold including any margin considerations. Does that help or just make things less clear, lol?
You are thinking in terms of the asset, not the portfolio. Yes, what you say makes sense if you think of the assets separately, it’s basically the covered call argument.
Let’s add an asset. Cash. I need 10% less of my portfolio in XYZ right now and I need 10% more in cash, because I have too much risk allocated to XYZ (or alternately, because i need something to buy ABC with). That’s what rebalancing is like. Now, do I sell XYZ with a limit order today or write 10%*AUM/stockPrice/contractSize calls on XYZ? The options expire in one month. And if I need to buy ABC, what do I buy it with?
Maybe the real issue is why you use a limit order here. Is the limit sell order below the current price and just to make sure you don’t get taken to the cleaners by doing a market order, or is the limit order above the current price in the hopes that it will get there before you rebalance?
This
There is no “limit sell order below the current price”. That would be a market order.
“Limit 100” means “100 or better”. If it’s a sell order, the current price is $105, then the price is better than $100, and the order is executed immediately.
If it’s a buy order and the current price is $95, then the current price is below the limit (“better than” the limit), and the order is executed immediately.
bchad - I see what you’re saying, I’m slow like that.
Err… I have to reiterate that limit orders are like a “one touch” option. They close out your whole position at the limit price. Call options are not “one touch” - your position will still be live! And, you will be in a disadvantaged risk position around the strike. This is a material difference, and it is what you pay in return for the call premium (there is no free lunch).
Technically, you’re right. My point is that you see a price on your screen (what I called the market price) and you may put in a limit order with the price set a few cents below that price so that it is likely to execute quickly, but not at a substantially lower price. If the market price is above your limit, you’ll get the market price, but you aren’t exposed to large change just because you had a market order.
Obviously you could put a limit order a little above the last price, but then you may never get filled. If you are rebalancing, you need to get filled (though some people are able to wait longer and therefore will try a higher limit).
Ohai, can you be a bit more specific about “a disadvantaged risk position around the strike”? It sounds plausible, but I’m not sure what you mean here - is it just that gamma is large around the strike esp close to expiration?
^Maybe this is a limitation to my exposure in the industry, but if the stock is selling at $95, why would you enter a sell limit of $94.95? And why would you enter a sell limit order at $95.05? You’re risking lots and lots of green for what amounts to a few pennies.
I don’t really understand limit orders. I understand how they work, but I just don’t see a lot of reasons why someone would really want to use them. In the above example (either one), if you use a limit order, and the stock immediately drops to $94.94, then you’re still holding it. It could go Enron and you’d still be holding it.
Better to be approximately right than exactly wrong, IMHO.
Simplified case: If you hold a covered call at the strike, if market goes up 10%, you make no money. However, if the market goes down 10%, you lose 10%. Gamma is highest at the strike and near expiration, and this is where you will observe this behavior the most.
Compare that with the limit order, where your position is closed out at the same strike price. If market goes up 10%, you make no money. However, if market goes down 10%, you lose no money.
Also, let’s say you sell OTM calls and then the underlier moves to near the strike (but expiration is a while away). The option will have more “time value” compared to where you sold it. Meaning, you have an unrealized loss on the option position, which you would not have if you just placed a limit order.
It sounds like you’re not really rebalancing then. You’re saying, I’ll sell some in a month, and I might as well get some extra premium, and I don’t think it’s likely to go much above (strikePrice+premium) and I’m not going to be too upset if if it rockets to the moon before then.
That’s a fine strategy to make money, but it’s not really about rebalancing, it’s more about trying to make some money through a covered call before you your next portfolio reblance. Which is also fine; it’s just not rebalancing.
It’s weird (in my mind) to link the call with the rebalancing, unless you do it in the following way. “I’ll rebalance my portfolio when the covered call expires, and determine the proper quantities to buy and sell that time; for now, I estimate that I will be reblancing approximately X dollars worth of shares at that time, therefore I can write Y number of contracts.”
That helps a lot. Thanks!
A market order is an invitation to be bent over a barrel and given the worst possible price given the environment (which can change from microsecond to microsecond) and there are plenty of HFT algorithms specifically designed to sniff out this stuff and give you the figurative shaft. Therefore, I’ll often use a limit order at a price that is a touch below the price on my screen, which may be a stale figure that no longer applies. With this kind of limit order, if the price has improved, I may get it, but at least I’m not going to get blown away. If the limit order isn’t filled after a while, then I may need to check on what’s happening and adjust the price.
Part of it is that my strategy isn’t hyper-dependent on pennies here or there, because my hold times are long enough, but I dislike the vulnerabilities of a market order. The only time I use market orders are times when stops are hit, and those are technically stop orders, not market orders, even if they show up on traders’ screens as market orders.
Generally it’s best to use limit orders for everything except emergencies. With emergencies, sometimes the market is falling faster than your limits can accomodate, so a market order may be better than waiting for a limit to be filled and having the market crash further if the market is in freefall. It’s really hard to know what the right thing to do in something like a flash crash or a 1987 type event. Ideally, you have puts that can bail you out, but those puts need to be held beforehand and are expensive (even more expensive afterwards).
I don’t see a reason not to use a market order for most liquid large caps…who cares if its a few cents above or below?
For microcaps, obviously different story as they may only trade once a day.