Maximize Compound Interest [1]

This article discusses the basic concepts and how to materialize and maximize compounding growth in the stock market.

A few days ago while I was stuck in the heavy traffic of Silicon Valley,  I listened to a financial radio program .  The host invited a real estate investor who bought a house 20 years ago.  In the last 20 years,   Silicon Valley housing market is booming. Then he started to talk about the extremely high reward of that investment, which he said it was doubled every year ! (Bad signal, I might have a bad memory). I immediately realized he must be joking and something must be wrong in his calculation. Assuming a $ 50,000 investment 20 years ago, 100 percent return per year after 20 years is: 1+100%)20 = 5×1010, which is 50 billion dollars! OMG, that lucky guy just became one of the the world’s top 10 richest man by purchasing a house, too easy! For those neophytes,  if he can follow a wise man who continuous double, after 10 or 20 years, would not be easy to become a millionaire or billionaire.

As can be seen, although the annual 100% return is not sustainable, but the use of time compounding long-term stable growth is the magic of accumulating wealth. Einstein once commented on compound rate:

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

Compound interest is that you reinvest the interest you earned each year and then take tat together with the principal investment, the absolute value of the growth rate of earnings faster. Einstein also discovered the Rule of 72, which can be simply estimate how long it will take to double for a give compound interest rate, here is the formula:

Years to double = 72 / Interest Rate

 If the annual interest rate (APR) is 9%, then in the case of compound interest is calculated once a year, your investment will be doubled in eight years. You invest  of $100,000 in the first eight years will become $ 20,000, and reach $ 1,580,000 to 32 years . If the annual income is 18 percent,  you will get 20 million dollars after 32 years. 18% a year seems to be too easy, but it is not easy to maintain every year. Our goal is to achieve feasible, repeatable, scalable , low risk investment which we can maximize compound interest.

 

yr
1
2
3
6
8
12
24
32
 
 
0% $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00
1.00% $101,000.00 $102,010.00 $103,030.10 $106,152.02 $108,285.67 $112,682.50 $126,973.46 $137,494.07
2.00% $100,020.00 $104,040.00 $106,120.80 $112,616.24 $117,165.94 $126,824.18 $160,843.72 $188,454.06
3.00% $103,000.00 $106,090.00 $109,272.70 $119,405.23 $126,677.01 $142,576.09 $203,279.41 $257,508.28
4.00% $100,040.00 $108,160.00 $112,486.40 $126,531.90 $136,856.91 $160,103.22 $256,330.42 $350,805.87
6.00% $100,060.00 $112,360.00 $119,101.60 $141,851.91 $159,384.81 $201,219.65 $404,893.46 $645,338.67
8.00% $108,000.00 $116,640.00 $125,971.20 $158,687.43 $185,093.02 $251,817.01 $634,118.07 $1,173,708.30
9.00% $109,000.00 $118,810.00 $129,502.90 $167,710.01 $199,256.26 $281,266.48 $791,108.32 $1,576,332.88
12.00% $112,000.00 $125,440.00 $140,492.80 $197,382.27 $247,596.32 $389,597.60 $1,517,862.89 $3,758,172.63
18.00% $118,000.00 $139,240.00 $164,303.20 $269,955.42 $375,885.92 $728,759.26 $5,310,900.63 $19,962,927.70
24.00% $124,000.00 $153,760.00 $190,662.40 $363,521.51 $558,950.67 $1,321,478.87 $17,463,063.93 $97,609,912.89
  • Feasible:  non-professionals do not need to spend a lot of time and effort required to track more than 10 stocks, or time the market, passive or semi-passive management should be sufficient to ensure the reward. a.k.a to achieve the optimum reward on the time invested.
  • Repeatable:  That strategy can be used repeatedly, that is, when an indicator appears, according to the principles of the preset operation.
  • Scalable: The performance of the strategy won’t be worsened with escalating cost if the scale of investment is increased. For example, for securities of the low liquidity, such as certain options and small-cap stocks,  price can be go up or down drastically because we buy or sold transaction, leading to lower reward and a sharp rise of investment costs. Some strategies which is feasible when asset is $1,000,000 will become unpractical when the managed asset zoomed to   $100,000,000.
  • Low risk: return on investment is relatively stable, less ups and downs.

I would like to discuss the practical trading strategies to maximize compound rate from the aspects of  steady growth, compounding frequency, security selection, dividend reinvestment, covered calls, short puts with intent to buy, taxes & fees.

1. Steady growth. Take a look at Berkshire Hathaway, S & P 500 and 2x S & P 500’s performance in this century.

 
BRK
SPX
2xSPX
20006.50%-9.10%-18.20%
2001-6.20%-11.90%-23.80%
200210.00%-22.10%-44.20%
200321.00%28.70%57.40%
200410.50%10.90%21.80%
20056.40%4.90%9.80%
200618.40%15.80%31.60%
200711.00%5.50%11.00%
2008-9.60%-37.00%-74.00%
200919.80%26.50%53.00%
201013.40%15.10%30.20%
20114.60%2.10%4.20%
201214.40%16.00%32.00%
201318.20%32.40%64.80%
mean9.89%5.56%11.11%
Stdev0.0910.1990.398
compound rate9.51%3.60%1.64%
Investment of $100K on 1/1/2000$356,880$164,135$125,560

Buffet’s (BRK.A/BRK.B) performance of these years is not as great as his heyday, but still quite outstanding comparing to S&P. Take a look at 2xSPX (this is just an analog 2x yearly performance, real 2x daily SPX ETF performance might be more volatile). In the past 14-year period, it rose more than 30 percent six times, only decline over 30 percent twice. The arithmetic mean of 11.11%, much higher than 9.89% BRK’s. But BRK 14-year compound rate was 9.51%, total revenue is + 256.88%, while 2xSPX the compound rate is only 1.64%, the total reward is only + 25.56%, and even worse than buy & hold treasury bond. Why? The answer on the standard deviation, in these 14 years, BRK never fell more than 10% once, there was only one year it rose than 20%, the highest increase was a mere 21% (I believe lots of investors can easily beat Buffet once, but may not beat him in a long run!). BRK standard deviation is 0.091, while 2xSPX drop more than 20% for three times, standard deviation is 4 time of that of BRK! It seems the problem lies in the fall, 2xSPX decreased by 74% in 2008, then what is the percentage it can rose to break even, remember: not + 74%, but a startling + 285%! That is continuous growth in 15 years at an annual rate of 9%! So remember Buffet’s famous quote: Rule No.1: Never lose money; Rule No.2:. Never forget rule No.1!

Therefore, without influx of fund, if the investment is wiped out, it would take almost forever to recover. So what kinds of securities can be surely forfitable giving unlimited time? As long as the money can pay interest or dividend, there is always a day the interest or dividend paid will surpass the principle! There are categories of interest or dividend yield investments, the risk from low to high, are CD (Certificate of Deposit)s, treasury bills, notes and bonds, municipal bonds, cooperate bond, Real Estate Investment Trust (REIT), utility stocks, preferred stocks, Master Limited Partnership (MLP) . We will discuss the pros and cons of various investment securities in the third part of the series.

2. Compounding Frequency

An overlooked factor is the compounding frequency. Stock or fund dividends can be paid yearly, quarterly or monthly. If every time the dividend reinvest, then the next dividend payment is will be calculated based on the latest principal, which is the sum of last dividend paid and the principal of the previous period, and that is compounded growth.

We will compare the APR (Annual Percentage Rate) 4%, 6%, and 8% with monthly, quarterly, annually compounding.

compound frequency
Annually
Quarterly
Monthly
Annually
Quarterly
Monthly
Annually
Quarterly
Monthly
yr4.00%4.00%4.00%6.00%6.00%6.00%8.00%8.00%8.00%
1$100,040$104,060$106,136$100,060$1,061,364$1,061,678$108,000$108,243$108,300
2$108,160$108,286$112,649$112,360$1,126,493$1,127,160$116,640$117,166$117,289
3$112,486$112,683$112,727$119,102$1,195,618$1,196,681$125,971$126,824$127,024
6$126,532$126,973$127,074$141,852$1,429,503$1,432,044$158,687$160,844$161,350
8$136,857$137,494$137,640$159,385$1,610,324$1,614,143$185,093$188,454$189,246
12$160,103$161,223$161,478$201,220$2,043,478$2,050,751$251,817$258,707$260,339
24$256,330$259,927$260,753$404,893$4,175,804$4,205,579$634,118$669,293$677,764
32$350,806$357,385$358,899$645,339$6,724,398$6,788,405$1,173,708$1,261,310$1,282,639

As can be seen, if it is 8% APR, after 32 years, monthly compound has been higher than the yearly compound of more than 10%. Obviously, if APR is fixed, the frequency of dividend payment, the higher the ultimate benefits (higher APY). If a stock can pay dividend weekly or monthly, that will be ideal to grow compounding interest. If not, we can take advantages of covered call or diagonal spreads to enable the weekly dividend for ourselves.

 

 

 

 

 

 

 

 

 

 

 

复利的最大化-【1】

本文科普复利的基本概念和探讨如何在股市中实现复利增长。科普部分大牛可跳过。

几天前边开车边听硅谷某华语电台的财经节目。里面一位大佬谈到20年前买了一栋投资房,结果这20年硅谷房市火热,总体投资回报平均每年翻一翻!(信号不好,可能有误)。我立马趴下了。虽然书读得不多,但我还是能知道那位老大那个地方计算有误。假设20年前投资50,000元,那么按大佬所说的每年100%回报,20年后就是:$50,000 x (1+100%)20 = 5×1010,也就是500亿美金!OMG,买个黄子就能跻身世界首富前十位,太容易了!板上如果有大牛能连续double,青蛙只要跟个10年20年,岂不是轻松成为千万富翁,亿万富翁了。

可以看出虽然每年100%不可持续,但利用时间复利长期稳定的增长是积累财富的法宝。爱因斯坦是这样评论复利滴:

“复利是世界第八大奇迹。了解它,就有得赚,不了解它,就有得赔。”
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

科普一下复利,就是你把每年赚的部分加上本金再拿去投资,在收益率一定的情况下,收益的绝对数值增长速度越来越快。爱因斯坦老人家还总结了72法则,即翻倍的速度是72除以百分比。如果年收益是9%,那么在每年计算一次复利的情况下,您的投资将在8年翻一翻。您投资的100,000美金,在第8年约为为$20,000,到第32年成为$1,580,000,轻松成土豪。如果年收益是18%,到32年将得到2千万美金。18%一年对于本版的大牛来讲不要太轻松,但年年保持并不容易,我们的目标是实现可操作,可复制,可规模化,低风险的前提下实现复利最大化。

yr
1
2
3
6
8
12
24
32
 
 
0% $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00
1.00% $101,000.00 $102,010.00 $103,030.10 $106,152.02 $108,285.67 $112,682.50 $126,973.46 $137,494.07
2.00% $100,020.00 $104,040.00 $106,120.80 $112,616.24 $117,165.94 $126,824.18 $160,843.72 $188,454.06
3.00% $103,000.00 $106,090.00 $109,272.70 $119,405.23 $126,677.01 $142,576.09 $203,279.41 $257,508.28
4.00% $100,040.00 $108,160.00 $112,486.40 $126,531.90 $136,856.91 $160,103.22 $256,330.42 $350,805.87
6.00% $100,060.00 $112,360.00 $119,101.60 $141,851.91 $159,384.81 $201,219.65 $404,893.46 $645,338.67
8.00% $108,000.00 $116,640.00 $125,971.20 $158,687.43 $185,093.02 $251,817.01 $634,118.07 $1,173,708.30
9.00% $109,000.00 $118,810.00 $129,502.90 $167,710.01 $199,256.26 $281,266.48 $791,108.32 $1,576,332.88
12.00% $112,000.00 $125,440.00 $140,492.80 $197,382.27 $247,596.32 $389,597.60 $1,517,862.89 $3,758,172.63
18.00% $118,000.00 $139,240.00 $164,303.20 $269,955.42 $375,885.92 $728,759.26 $5,310,900.63 $19,962,927.70
24.00% $124,000.00 $153,760.00 $190,662.40 $363,521.51 $558,950.67 $1,321,478.87 $17,463,063.93 $97,609,912.89
  • 可操作是指非专业人士不需要需花费很多时间和精力跟踪10只以上的股票,或time the market,passive或半passive 管理足矣。
  • 可复制是指可以反复使用,即当某项指标出现时,即可按预先设定的原则操作。
  • 可规模化是指在投资成本不会因为投资规模扩大很增加,例如如果大量购买流通性较差的证券,如某些期权和小盘股,就会抬高该证券的价格,导致成本急剧上升。
  • 低风险是指投资回报率比较稳定,少大起大落,不见外婆也不爆,一点不吸引眼球。

以下从稳定增长,复利频率,证券选择,dividend reinvestment, covered calls, short puts with intent to buy, tax & fee consideration  这几个方面来和大家探讨最大化复利具体操作。

1. 稳定增长。先看看Berkshire Hathaway, S&P 500 和 2x S&P 500在本世纪的表现。

 
BRK
SPX
2xSPX
20006.50%-9.10%-18.20%
2001-6.20%-11.90%-23.80%
200210.00%-22.10%-44.20%
200321.00%28.70%57.40%
200410.50%10.90%21.80%
20056.40%4.90%9.80%
200618.40%15.80%31.60%
200711.00%5.50%11.00%
2008-9.60%-37.00%-74.00%
200919.80%26.50%53.00%
201013.40%15.10%30.20%
20114.60%2.10%4.20%
201214.40%16.00%32.00%
201318.20%32.40%64.80%
mean9.89%5.56%11.11%
Stdev0.0910.1990.398
compound rate9.51%3.60%1.64%
Investment of $100K on 1/1/2000$356,880$164,135$125,560

Buffet这些年的表现已大不如他的鼎盛时期,但仍然非常出色。先看看2xSPX(这只是模拟2x yearly performance,真的2x daily performance 更夸张)。这14年来有6年涨幅超过30%,只有2年跌幅幅超过30%,算术均值为11.11%,远高于BRK的9.89%。但BRK 14年的compound rate是9.51%,总收益是+256.88%,而2xSPX的compound rate只有1.64%,总收益只有+25.56%,连买bond都不如。为什么?答案在standard deviation 上,14年来BRK没有一次跌幅超过10%,也仅有一次涨幅超过20%,最高涨幅是区区21%(相信诸位牛人能轻松beat Buffet)。BRK standard deviation是0.091,而2xSPX有3次跌幅超过20%, standard deviation是BRK的4倍!看来问题出在下跌上,2008年下跌74%,那么上涨多少才能break even,记住:不是+74%,而是+285%!即以每年9%的速度,要连续增长15年才能break even!所以请记住Buffet的名言:Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.投资规则第一条:不要亏钱,第二条:记住第一条!

所以在没有外来资金注入的情况下,如果被外婆,将take almost forever to recover。那么哪些证券能在时间无限的前提下,能实现不lose money呢 (beat inflation 另议)?只要能保证钱能生钱,生出来的钱总有超过principle的那一天!有interest或dividend的类别yield和风险从低到高大概有 CD,treasury bills, notes and bonds, municipal bonds, cooperate bond,real estate investment trust (REIT), utility stocks, preferred stocks, master limited partnership (MLP)。我们将在第三部分证券选择中讨论各种投资的利弊。

2. 复利的频率

一个被忽视的因素是复利的频率。股票或基金能每年发放一次红利,或每半年发放一次红利,或每季度年发放一次红利,或每月发放一次红利,如果每次都将红利reinvest,那么下次发放红利是就要根据最新的投资总额来派发,这就是复利增长。

我们仅比较一下APR (Annual Percentage Rate)是 4%,6%,和8%的情况下,monthly,quarterly,和annually compound的差别。

compound frequency
Annually
Quarterly
Monthly
Annually
Quarterly
Monthly
Annually
Quarterly
Monthly
yr4.00%4.00%4.00%6.00%6.00%6.00%8.00%8.00%8.00%
1$100,040$104,060$106,136$100,060$1,061,364$1,061,678$108,000$108,243$108,300
2$108,160$108,286$112,649$112,360$1,126,493$1,127,160$116,640$117,166$117,289
3$112,486$112,683$112,727$119,102$1,195,618$1,196,681$125,971$126,824$127,024
6$126,532$126,973$127,074$141,852$1,429,503$1,432,044$158,687$160,844$161,350
8$136,857$137,494$137,640$159,385$1,610,324$1,614,143$185,093$188,454$189,246
12$160,103$161,223$161,478$201,220$2,043,478$2,050,751$251,817$258,707$260,339
24$256,330$259,927$260,753$404,893$4,175,804$4,205,579$634,118$669,293$677,764
32$350,806$357,385$358,899$645,339$6,724,398$6,788,405$1,173,708$1,261,310$1,282,639

从中可以看到,如果是8%的APR,经过32年,monthly compound已经要比yearly compound的收入高出10%以上了。显然,在APR一定的情况下,发放红利的频率越高,最终的收益越高。如果这只股票能每月甚至每个星期都发红利,那就最好不过了。如果没有,我们可以创造条件,利用covered call或diagonal spread给自己发红利!

我们下次接着讨论。

 

 

 

 

 

 

 

 

Mid Term Call Strategy – Near The Money Call

We briefly discussed the short term strategy which utilizes DOTM (Deep Out Of The Money) Call to bet earning report. The stock can go either direction to certain level. Nevertheless, there is a option strategy to make a profit: We might long calls to profit from sudden jump, long puts to profit from plummeting stocks, long strangles or straddles, short iron condors to profit from drastic movement in either direction, or you might bet against no drastic, but no movement or mild movement by longing iron condors or shorting strangles/straddle. However, you should remember no matter what kind of setup you decide to take, your counterpart, very likely a market maker (MM), has already place the bid based on their sophisticated algorithm which is in favor of themselves. At the end of day. I mean at the end of market close of expiration day, MMs are likely the ones who profit eventually.

In the previous discuss of short term strategy,  theta (time decay) is the archenemy of DOTM (deep out of the money) near expiration call owner and the stock must appreciate rapidly. Theta can be found to describe the negative impact of time (i.e decreasing time value) pass to option price for both calls and puts. If delta is -0.80 (delta is always negative unless we can rollback the clock), which means the option will be devalued by $0.80 if other factors remain the same. The diminishing of time value accelerates when there is only 2 weeks left and race to the climax on the expiration day. If you need more leeway to allow your stock of interest to appreciate, you can choose Near the Money (NTM) Call which has approximately 2 months to expire. By that way, we will have sufficient time to ride the tide, but also have followup strategies when the tide is against us.

Each person has his own standard to pick stocks. I personally prefer the self-invented “3M” system to increase the probability of success:

1)Momentum: The underlying stock just breaks up and is in a confirmed uptrend, which is supported by favorable technical indicators and fundamentals.

2) Multiple non-correlated evidences, such as:

  •  The stock is recommended by Investors Business Daily and/or  Barron’s, such as it is on IBD Top 50 or one of the sector leaders.
  •  Phenomenon observed by myself, such as long line when dinning at Chipotle Mexican Grill, more electric cars on streets or in parking lots, more handbags of a brand, a full house of customers in Nordstrom, huge new job listing of your neighboring company (which usually means a M&A event might be imminent)
  •  Outperforming sectors:such as new energy, biotech and internet stocks of last year.

3)Market: We expect market will remain stable or maintain the uptrend. However, if there is a significant correction, most stock will go down with the broad market, no matter how pretty your chart appears to be.

We can purchase a high value, liquidated stock with delta around 0.5 and expect a ROI of 3-5 folds.

Here is a breakdown analysis of Greeks and I just assign an subjective probability value for simplicity:

delta: Let’s just assume we have a very nice pick and the uptrend will maintained. The probability of a winning delta is 80%.

gamma: The movement  (of either direction) can be accelerated or decelerated, P = 50%.

vega: If only consider the price of the expiration day, vega is not relevant.

theta: The time decay of the 1st one and half months are still manageable. Let’s just assume it will devalue 30%, or 70% favorable.

Overall, we have probability of 28%, not bad if we can gain 5x ROI.

Take home messages:

1. relatively low probability (not terribly low as DOTM),relative high ROI (not as high as DOTM),limited loss.

2. Followup possible: If the stock appreciates but time is running out, we can roll forward. If the stock is skyrocketing, we can roll up and let the profit run.

3. replicable, but ROI is not guaranteed. If we are successful one out of three trades (100% loss in 2 trades), we are only break even when we get 300% ROI on the winning trade. However, the probability of higher ROI will go much lower.

4. Not scalable: Except for those high volume liquidated stocks, Market Makers won’t allow you to purchase a great deal of NTM calls. They will lift the ask price when you are buying.

In essence, we can optimize our approaches to make right picks by refine our technical analysis and fundamental analysis, we can reveal more irrelevant events to predict the direction of the underlaying stock. However, we do not have the capacity to control the market and avoid adverse impact of an unexpected events. Thus, a prudent investor should have a sound exit strategy in mind before he press the buy button. Good luck!

 

买Call中期策略- Near The Money Call

上次讨论了短期策略利用DOTM (Deep Out Of The Money) Call来赌 ER。当然赌earning report的各种各样的期货玩法。赌剧烈运动的可以bet大涨 (long call),大跌 (long put), 大涨或大跌 (long strangle/straddle 或 short iron codor), 也可以bet小幅波动  (short strangle/straddle 或 long iron condor)。请牢记无论选择那种玩法,您的对手(买方/卖方),Market Makers一定计算好了的赔率并设定了对他有利的价格,笑到最后的很可能是他们。

在短期策略中, theta (time decay) 对call持有者是个巨大的威胁,股票必需在很短的时间内快速上扬。这里theta用来表示时间对期权价格的影响。如果theta指为-0.80 (注意theta 只能是负值),这表明在股价和其它因素不变的情况下,第二天该期权的价格将下降80c。通常对有time premium 的call在最后两个星期,time value开始显著下降,到expiration day达到最低值并趋向0。如果您需要更多时间让股票增值,可以选择二个月左右的Near the Money (NTM) Call, 这样就有充分的时间ride the momentum, 如果风向不对,也有机会补救。

个人有不同的选股标准,我比较倾向于我自创的3M体系来提高成功率:

1)Momentum(动能): 股票正处于突破后的上升趋势中, 有良好的TA指标和基本面。

2) Multiple non-correlated evidences (多个互不关联的证据),如:

  • 大牛, Investors Business Daily 或 Barron’s 推荐, 如 stock on IBD Top 50 or section leader
  • 客观观察到的经济现象: 如CMG要排长队,LD最近爱到Nordstrom 扫货,街上和parking lot里某种牌子的电动车大增,隔壁某公司忽然大举扩张(通常是并购前兆)等。
  •  Outperforming sectors: 如去年的新能源,生物科技和互联网等

3)Market(大市走向):我们期望市场平稳或上扬,但如果出现较大幅度的调整, 股票往往会跟随大市向下, 再好的momentum可能也无济于事。

我们可以选择流动性较高, 股票价格较高(以后专文讨论),delta 0.5左右的call,预期获得3-5倍的回报。

大概分析一下Greeks对期权价格的影响:

delta: 假定该股票会保持趋势,继续上行,胜率 80%。

gamma: 加速减速各半,各 50%。

vega: 振幅可高可低,但如果只考虑到期日的情况,则与之无关。

theta: 前1个半月theta的影响较小, 假定 70%。初步算来盈利的可能性为28%

总结:

1. 较低概率,较高回报,损失有限, 但盈利无上限。

2. 可以有后续手段: 如果上涨但速度不够, 您可以Roll forward得到跟多的时间,如果快速上行,您可以roll up 获得更高的利润。

3. 可重复,但收益难以保证:假如买对3次,一次成功(33%)得到3倍的回报,其他2次亏光,ROI仍是0。如果成功的那次得到5倍的回报,则ROI为67%。

4. 不可规模化:除某些交易量巨大的股票外(如GOOGL),您也不可能以同样的低价格购买到大量的 NTM call。在您买进的同时,MM会逐步抬高call的价格。

总之,我们可以优化我们利用技术指标来判断动能的方法,可以找到更多不互相关联的证据来支持股票上涨的观点。但我们无法左右大盘的走向和突发事件的发生,投资者应该在买入时就有exit  strategy,有备无患。下文将分享我个人的经验和教训。

Short Term Strategy By Owning Calls

We briefly introduced factors which influence the price of an option, such as delta, gamma, vega and theta. The value of a delta can be qualified as the correlation of the option and its underlying stock. If a stock goes up $1, and a call goes up 80c, and a put goes down 30c, delta of that call is 0.80 and delta of that put is -0.3.  The deeper the strike price goes into the money, the higher the correlation, approaching 1 for call and -1 for put. Thus delta of a call is between 0 and 1 and delta of a put is between -1 and 0.

It is generally believe that the market will remain bullish in the next couple of years, most stocks will follow the trend and go up. Thus, I would like to discuss the riskiest short term call “strategy” first.

Short Term (less than 2 weeks) – Bet Earning Report with Deep Out of The Money Calls

If you are right about the market response to an earning report, you may achieve 100 fold or higher reward. Today is July 24, 2014. Visa will release its Q3 2014 earning report after market close. Current price of V is $223 and its Deep Out Of the Money (DOTM)call option,  V Jul25′ 235 Call has bid/ask of 0.13/0.20, delta is 0.05,with unlimited reward and limited risk, that is $13 (use bid price) per contract. If V goes up to $224, the call will goes up 1 delta ($0.05), that is $0.18.

V Jul25 14 235 Call

IF Visa’s ER greatly exceeded the expectation and its share price went up 10%, that is $245. Congratulations! You will instantly achieve 100 fold ROI , that is, a single contract will worth approximately $1000  (intrinsic value is already $245- $235 = $1,  $10 X 100 = $1000). That sounds great, huh? However, what if its ER is great but market response is little bit lukewarm and V ONLY appreciated 5.5% to $235 by 4PM ET July 25 2014? I am sorry, all of the call became worthless.

Here is a breakdown analysis of Greeks and I just assign an subjective probability value for simplicity:

delta: Let’s just assume you are a stock guru, we have inside information, ER is fantastic and market responds positively (ER beat does not necessarily guarantee a positive market response). The probability of a winning delta is 75%.

gamma: The movement  (of either direction) can be accelerated or decelerated, P = 50%.

vega: After earning report is released, the uncertainty diminished quickly, which will cause the collapse of vega and the depress the option price. P = 10%.

theta: Very negative when it is close to expiration day. Since it is Deep Out of The Money (DOTM), the chance of the underlaying climb to the strike are quite slim. P = 20%.

Overall, the probability of profit based on my subjective probability is 0.75%. Actually, OptionHouse provides a probability calculator. The probability to reach the break even ($235.13) is 10%, and the probability to achieve 100 fold ROI is 0.5%. How is that? The probability is approximately the same as  8 heads in a row!

V Probability

Take-home messages:

1. Low probability, high ROI, limited loss with unlimited potential.

2. No time for followup actions: V Jul25′ 235 Call的bid/ask spread is 50%,  it will expire tomorrow (July 25, 2014). It is too costly and has no time to take sensible followup actions.

3. Non-replicable: It seems easy to bet correctly once, but it is impossible to bet correctly consistently.  Have you seen anyone who won lottery more than once?

4. Non-scalable: It is impossible to acquire large amount of these kind of DOTM calls. The maximum is $6760 for 338 V Jul25′ 235 Calls. When market makers (MM) see someone is accumulating, they will ruthlessly skyrocket the call price, this will definitely cut into your ROI.

Giving the extremely low P and high ROI,  shall we play it? Personally I redeem it more like lottery. We all buy lottery, but the goal of buying lottery is entertainment, not investment or winning a large lump sum. We won’t using our down payment to purchase lottery tickets or this kind of DOTM calls.  The DOTM call strategy can be served as a way of entertainment. With $13 a pop and an unlimited dream, it is not a bad game to play.

P.S: At 4:30 PM ET, V released better than expected earning report,but stock plummeted. It is very like the V Jul25′ 235 Call will expire worthlessly.

 

 

 

 

 

买Call短期策略

上次的期权风险初探从趋势上讨论了影响option价格的一些因素如方向(delta), 加速度(gamma),振幅(vega)和时间(theta)等。我们在这里先量化delta: 它是指股价变化对期权价格的影响。如果股票上涨$1, 某个Call 上涨80c,则该Call的delta为0.80, 某个Put 下跌30c,则该Put的delta为-0.30。delta实际上是测量了期权价格和股票价格的关联度,call的delta在0和1之间,而put的delta在-1和0之间。

个人认为市场在未来1-2年内将会维持平稳向上的趋势,个股也以看涨为主,因此先抛砖探讨Call的短期玩法。

短期(2周以内)- 利用Deep Out of the Money Call 博ER

如果能赌对Earning Report的方向, 在很短时间会有高达上百倍的回报。Visa 会在今日收盘后公布2014年第三季度财报。V现价为$223,它的Deep Out Of the Money (DOTM)call option,  V Jul25′ 235 Call,现价为0.13, delta为0.05,可能的获利没有上限,损失有限,即每个合约$13。 也就是说如果V马上上涨至$224,该call将升至$0.18。

V Jul25 14 235 Call

如果盘后公布的财报远超预期,V上涨至$245 (+10%),恭喜!您得到了100倍回报,即每份合约$1000。听起来不错。不过如果盘后公布的财报虽然远超预期,但V到July 25收盘时只上涨至$235.00 (+5.5%),对不起,这些Call将为一文不值。大概分析一下Greeks:

delta: 假定我们是神算,有内幕,有大牛指点,ER果然beat,市场反应正面 (beat不一定涨,你懂的),胜率 75%。

gamma: 加速减速各半,胜率 50%。

vega: 财报公布后, 不确定性大减,一般vega会暴跌,胜率 10%。

theta: 非常负面,先假定在到期前能爬到in the money 的可能性为 20%。

粗略算下来的盈利的概率为0.75%。通过概率计算表格算出到$235,也就是break even的可能性为10%,而100倍盈利或以上的可能性为0.5%。这与连续投掷8次硬币,每次都是HEAD的概率相当。

V Probability

总结:

1. 低概率,高回报,损失有限,每单只要13刀,但盈利无上限。

2. 无法补救: V Jul25′ 235 Call的bid/ask spread 高达50%, 过一天就要到期, 来不及设法补救。

3. 不可重复: 猜中一次似乎不难,难的是反复猜中!见过老中lottery的吗?

4. 不可规模化:您不可能以同样的低价格购买到大量的 DOTM call。 您最大只能用 $6760 买到338 个 V Jul25′ 235 Call。当MM看到有人大量购入时,会豪不留情的抬高价格,不可能让您有那么高的回报。

Probability这么低,ROI这么高,该玩还是不玩?这是不是和我们都“玩”的Lottery有点像?只是我们玩Lottery的目的是娱乐,而不是盈利,也不会把down payment拿去全买了彩票。因此我们赌ER时,也要有娱乐精神,胜固可喜(记得回来发包子),败亦欣然,权当怡情花费,买彩票了。

后记: Visa 财报超出预期,但股票大跌, V Jul25′ 235 Call会expire worthlessly.

 

 

 

 

 

A Primer For Option Risk

Understand Option Trade

The higher the risk (or the lower the probability) , the higher the Return on Investment (ROI) and vice versa. We should reject any trade setup which associates with low probability and low ROI. In earning report (ER) season or a volatile market, deep Out-of-Money (OTM) options can be instantly doubled, tripled or zoomed to ten folds or higher.  However, it is extremely difficult for retail investors to profit from this kind of opportunities, or repetitively profit from those opportunities (It is a different story if you have insider information). On the contrary, Market Makers (MM) are more than happy to add extra amount of volatility premium on the option price to hedge their risks.

Some brokerage firms may provide the following information for options and option combos:  Profit Probability, Max Return, Chance of Max Return, Max Loss, Change of Max Loss。It looks like this:

SPXW price

SPX JUL25 ‘14 1975 CALL has unlimited profit potential, or grow N (N>1) folds. Of course, the bigger the N, the lower the probability.   Actually, at the current volatility level (VIX), the probability of double this call option is 15.86%. The distribution of probability looks like this:

SPXW probability

We will discuss the algorithm to calculate probability later . However, never put all your money in a position which Max Loss is 100% and Chance of Max Loss > 0%. There is 46% chance that this SPX JUL25 ‘14 1975 CALL may worth nothing at the expiration. If you put all your money in this position, you may be luck to make big money, but some unexpected events can easily wipe out all the positions.

Option Risk

Someone might experience and be upset when stock goes up sharply, but its call option changes a little or stays the same.  Here is an introduction to the factors which influence the price of an option. It is based upon owning a call option and expect the stock to appreciate.

1. Direction (delta)

If you pick the wrong direction, it is almost impossible to make a profit. Similar to owning a stock, if a stock goes down, it is very likely its underline calls goes down as well.

2.  Gamma

Even if you pick the right direction, but the stock goes up slowly. You can hold stock as long as it remains bullish, but you cannot hold a call like that. Although stock goes north, but it  has not surpassed the strike price and your OTM call becomes a ITM on the expiration day. I am sorry, your calls expires worthlessly.

3. Volatility (vega)

Suppose you bought a stock used to be a very volatile stock, goes up and down 3-5% percent daily, but become much less volatile recently.   That will adversely influence the call option. The higher the vega, the higher the premium on the option. Vega usually collapses after earning report is published when uncertainty is diminishing rapidly. That is the reason that you may bet the ER right but did make much from it.

4. Time (theta)

Time is the only factor which goes one way – down down down! A stock can go up or down, can accelerate or decelerate, can become more volatile or  less volatile. Time can only decay the option value! On the expiration day, theta is extremely negative for the near the money options. Vega and gamma simply run out of time to influence the option price.

5. Split & Dividend

Uneven stock splits,  such as GOOG split into GOOG and GOOGL, might add uncertainties to the option price. It is generally advised to avoid holding the option during this kind of stock splits. Dividend might greatly influence the call price of the value of dividend dwarfs the vega. In that case, you should exercise or sell the call to avoid loss. For example, on December 6, 2012, COSTCO issued a special dividend of $7 (7.2% of the share price). The next day COST closed down $5.36.  Holding a COST call option at market close of December 5th 2012 can result in huge lost because of the sizable dividend.

6.  Liquidity Risk

There is much less option traders than stock traders. Thus, there is usually huge spread between bid and ask price. It can easily make a 10% loss if you buy a option and  decide to sell it shortly.

Summary:

1. Investment is a Marathon, not a sprint.

2. Never all in a trade whose Max Loss is 100% and Chance of Max Loss > 0%.

3. To profit from owning an OTM call option,  you need to be on the right side of delta, gamma, vega and theta. You’d better avoid split and dividend.

Are you ready?

 

 

期权风险初探

看到坛子里大家对期权这么感兴趣,早就想把我一些教训和浅见和大家交流交流。今天终于把给合作方的胶片写完,注册了域名,争取能一星期写一篇博客。如果能帮助大家切磋技艺,少走弯路,就善莫大焉了。

读懂期权报价

期待的回报越高,可能性越低,反之亦然。 概率(Probability)和投资回报率 (Return on Investment ROI)总是此消彼长,高回报需要冒高风险,太稳妥是赚不了大钱滴。Out of The Money (OTM)期权可以在瞬间带来几倍,甚至几十倍的回报。但这种小概率事件是普通投资者很难捕捉到,或很难反复捕捉到(有内幕另当别论)。想反, MM们看透了散户一口想吃成一个大胖子,在ER前豪赌一把的心理,肆无忌惮地抬高期权的价格,抵消了卖期权者的风险。关于ER再专文讨论。券商可能会提供 期权或期权组合的Profit Probability, Max Return, Chance of Max Return, Max Loss, Change of Max Loss。是这个样子滴:

SPXW price

这个SPX JUL25 ‘14 1975 CALL有可能上涨N倍,当然N越大,可能性越小。事实上以现在的VIX水平,估算此call上涨一倍的可能性是15.86%。概率分布如下:

SPXW probability

关于概率的算法以后在专文讨论。当您看到Max Loss是100%而且Chance of Max Loss大于0%时就要小心了,这是说如果all in,您有被外婆的可能。这个本周到期的 SPX JUL25 ‘14 1975 CALL有46%的可能一文不值!所以玩期权千万别all in Chance of Max Loss大于0%的position, 可能很幸运这周没外婆,下周没外婆,但碰到要911这样的突发事件想不见外婆都难!

期权风险

童鞋们可能会碰到股票大幅上涨,Call仅微动或纹丝不动的情况。以下以Call为例简单介绍影响期权价格的因素。需要bet 对所有的因素都对了才能盈利!

1. 方向 (delta)

这是唯一和股票相同的地方。一旦方向判断失误,基本不可能盈利。买入股票和Call,如果股票下跌或不动,Call一般都会下跌。

2. 加速度 (gamma)

方向选择正确,却碰到只了慢牛,股票可以慢慢滴hold,但Call等不起。到了Expiration date,如果OTM还没有超过strike,成为In the Money (ITM),对不起,call expire了。

3. 波动性 (vega)

如果原来股票上窜下跳,现在服服帖帖的,vega给期权带来的影响为负值。反之为正。一般ER之后vega都会暴跌,所以很多ER bet了,期权却涨幅不大。

4. 时间 (theta)

时间是唯一一个单方向的影响因子。股票可涨可跌,加速度可快可慢,振幅可高可低,但除非时光倒流,时间只会给期权减值!Expiration day当天,Near The Money 的期权theta都是超级negative, gamma和vega都难以影响期权的价格。

5. 拆股和分红 (Split & Dividend)

不对称拆股,如GOOG拆分为GOOG和GOOGL给期权带来的影响很难预测,尽量不碰为佳。分红会给期权带来很大影响。一般如果能没有足够的资金 exercise, 应该在除息日前一天(ex-dividend day)将 call 卖出。例如:2012年12月6日,COSTCO 发放了$7 (股价的7.2%)特别红利。除息日股票下跌$5.36,如果您没有在ex-dividend day当天或之前卖出,将蒙受巨大损失。

6.  流动性风险 (Liquidity Risk)

期权的玩家远远少于股票的玩家。以此,绝大多数期权都有相当大的ask/bid spread。一买一卖就有可能造成10%以上的损失。

总结一下:

1. 投资是马拉松,不是短跑

2. 永远不要all in MaxLoss 100%且Chance of Max Loss大于0%的position

3. 要bet 对delta, gamma, vega和theta你的OTM 期权才能赚钱,期间最好不拆股,不分红,只涨, 飞快地涨才有的赚

童鞋们,你们准备好了吗?