Reversals and Conversions - Risk-Free Stock Options Trading Strategies

The Terry's Tips options newsletter features an options trading strategy that never loses money (according to a 10-year backtest which showed only 3 months with minimal losses out from 120 expiration months). However, we can't mathematically prove this strategy will usually turn at the very least a little profit on a monthly basis (we feel much more comfortable about producing the claim when an entire year is used as the time frame).

There are several options trading strategies that happen to be mathematically guaranteed to always turn a nice gain. Once I was a market maker trading on the ground of the CBOE, most of my time was taken up in order to establish positions that always made money, no matter where the stock price went.

The most famous technique was known as a reversal. It had been especially successful when most investors where in the pessimistic mood and also the prices for put options grew larger than the costs for call options. It is a fairly common occurrence.

Let's say that the stock price for XYZ (a non-dividend paying company) is $80, plus a two-month put at the 80 strike may be sold for $4.50 while a two-month 80-strike call can be bought for $4.00. If you search option prices, it is possible to invariably find choices on some companies with option prices similar to these.

With all the reversal strategy you don't care if the company has great potential or is indeed a dog - you will generate income no matter which way the stock goes. Any organization will work.

If you sell 100 shares of XYZ short, collecting $8000, sell an 80 put for $450 and get an 80 demand $400, you may have created what is called a reversal, and you will definitely produce a $50 profit, guaranteed (obviously, commissions would cut into this somewhat). Your eventual gain is a lot bigger than $50, however. To the term of your respective investment, you can expect to collect interest about the $8000 money in your account.

In case the stock goes to $90, at expiration you would have lost $1000 on the short stock however you would be able to sell your 80 call for exactly $1000, offsetting the loss (the put would expire worthless, obviously). In case the stock were to fall to $60, you might gain $2000 through your short stock but will have to buy back the short put for $2000 (as well as your call would expire worthless). In any case, there is no loss irrespective of what the stock price does.

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When you are trading on to the ground, you love several positive aspects which make reversals a viable strategy. First, it is possible to sell at the asked price and buy with the bid (in fact, you will be making the market for your options). It is then quicker to sell a put for more than the identical-strike contact you buy. Second, your commission expenses are negligible when compared with what you would pay in case your broker made the trades for yourself. And third, most of all, since you have formulated a danger-free position, your clearing house will extend virtually unlimited credit for your needs.

As I was actually a market maker, there was times I found myself collecting interest on several million dollars of short stock while not having one penny of my money at risk. It really is obvious why a seat on the CBOE sells for astronomical sums.

A comparable strategy (called a conversion) involves buying stock, buying puts, and selling calls. To ensure that this to work, enough time premium in the calls has to be in excess of the cost of the puts as well as high enough to cover the interest around the long stock for your time frame involved.

Reversals and conversions, while excellent plays for market makers, are hard to ascertain from off of the floor. Consequently, they are certainly not practical options for most investors.

An even more realistic alternative for ordinary investors is always to execute the 10K Strategy as featured at Terry's Tips. Although this strategy can't be mathematically proven to never lose money, a 10-year backtest (the details that we show to subscribers) shows that no losses resulted over any 12-month time frame, and that average annual gains from the neighborhood of 32% could have been made.

Using this strategy, initial positions are set up that will result in revenue if the stock moves moderately in either direction. As soon as the stock has moved about 5% in both direction, an adjustment is created that may expand the break-even range inside the direction how the stock has moved.

A significant part from the 10K Technique is the setting aside of money in the event that one of those adjustments becomes necessary. This spare cash signifies that portfolio protection may be kept in place if your stock turns around and moves within the other direction. If the stock is constantly move in exactly the same direction as it did originally, as second adjustment may be necessary to once more establish positions that will not lose cash. In those months every time a second adjustment becomes necessary, little or no gain can be expected.

These adjustments should not be that is set in place at the outset in the month because no-one knows which way the stock might move. Based on just what time period of the expiration month, the greater number of-than-moderate stock price move happens, different adjustments could possibly be called for. These adjustments add an "act of faith" dimension on the 10K Strategy which makes it impossible to mathematically prove which it will never lose value.