GE – A New Financial Cow for Our Growing Herd
Well, our milk-the-cow strategy has been going strong this year, after developing the strategy and working out the kinks in paper-based and live trading over the last 3 years. So we've decided to add a new cow to our growing herd, namely General Electric (GE).
For my smaller investors, I needed to find a stock that did not require a lot of margin, that offered an attractive rate of retail/wholesale options cost, that offered high frequency of options contracts (weeklies, preferably), and equally important, that offered low bid/ask spreads. These are all criteria for choosing a good candidate to generate maximum income from a strategy based on rolling options.
At around $6.00 a share, I could establish a long term strangle (buying out of the money puts and calls) for $4.10 per share or $410 per contract.
This puts an outer limit at possible losses if I am careful not to lose money on my frequent option rolls (milking my cow).
I sold my first at the money puts and calls on the same day at a 6.00 strike. Later that day I had to buy them back at a loss to reset the straddle to $6.50. I did so by rolling from the original July 31 sold strikes to Aug 7 sold strikes. This created a $9.50 loss per contract but a positive cash flow of $15.41.
As I'm writing this, on the next day, the stock has not moved much, but the options positions have turned profitable. The currently have a positive value of $209 if I were to close them.
size: 41 contracts
Long Term Hedge: $4,510 or $1.10 per share
Cash Flow to Date: $650 or $0.07 per share
P&L to date : ($95) or ($0.02) per share
Nice to see GE mentioned in this recent blog post 🙂
GE seems even more attractive now given the recent price drop in the underlying stock (currently around $6.07). I don’t know if this is foolish to think this way, but if it has already fallen this much, it makes further declines less likely. GE also has all of the potential to be a “comeback kid” if they can resolve their issues; so there could be a bullish outlook if one ends up long on the stock.
I think GE is the perfect stock for straddles and also potentially for doing only half of the Milking the Cow strategy (basically a calendar spread, with a short near-term put and a long LEAP put — or, given the cost of the LEAP put is $2.20, one could consider a cost-basis adjusted naked put assignment at $6.07 current GE stock price – $2.20 current premium for LEAP ATM 537-dte put = $3.87 as acceptable assignment risk).
For strangles, I am beginning to question whether GE is a good choice. The underlying price is too close to the strikes and it’s impossible to get 30-delta on both sides.
Please correct if this is wrong, but my understanding of the strategy is that one must continuously roll the short contracts to avoid assignment. With an ATM straddle, one side or the other is always going to be assigned so rolling for a credit is the only way to make money. The assumption is that in a high volatility environment, the market will overpay for expected move, and we can try and capture some of that overpayment when the market doesn’t move as much as expected. (With the LEAP straddle as insurance against an outlier event.) So this requires high and increasing positive theta over the time we own the contracts?
I have been testing GE strangles in a paper trading account. At least on the user interface that I have been using (thinkorswim), managing the strangles is rather difficult, and it’s easy to make a mistake rolling one leg or the other. It is much easier to manage straddles with only one number to worry about. However, I have to continuously make adjustments then. I am going to research using slightly longer terms (e.g. buy at 28 DTE, roll at 21 DTE) to see if it relieves some of the management burden.
Hey Preston,
You may be interested to check out the experiment I made with short strangles vs straddles on two stocks. Please see the new topic in the forum “Best Levels to Set The Short Positions”.
I did a quick and nasty test on two stocks and found the straddles WAAAY more profitable. A lot more maintenance and action required, but one is paid handsomely for the extra work.
I’d love to see someone test this approach on a large data set going back a couple of years. Maybe it will prove me wrong. BTW, when I first launched on this strategy I was using delta 25’s and 30’s. I made money, but a lot less than now.
Thanks, Serge, I will check it out! Interestingly, I got assigned on a GE ITM call last week on Thursday (1 full day before expiration), it was no problem of course (I am just moving it to a covered call play), but I was not expecting that. It is definitely something that happens and not only in the final hours of the expiration day…
Hi again,
I looked at the numbers are you are 100% correct. ATM straddles are the only way to go. Rather than running any sort of back testing, I simply looked at the theta for the short positions versus the long ones. As the strikes get farther out of the money, the ratio of short/long theta starts to approach 1 very quickly (well before 30 delta). Thus there is no time advantage in the long versus short positions. In contrast, ATM the short/long theta ratio can be (with the proper underlying stock selection) be 4 or even 6 or greater.
Preston,
Thanks for that imput.
Yes, theta decay drops the further you get from the strike. This is why I prefer to undergo the “friction” of trading (bid/ask spreads/fees) more frequently as opposed to lesser time decay.
This link shows that for other readers who are maybe less knowledgeable than you:
(click to enlarge)
What the image does not show is the time decay of the LEAPS. At the money leaps lose about 4 cents a day on the LEAPS. So if you can get 20 cents on the weeklies you have an inherent potential advantage of 5 to 1. That’s what Preston was talking about.