How to Save Buying Power
Oct 3, 2016
By: Josh Fabian
One of the biggest challenges tasty bite accounts face is creating enough occurrences (trades) and maximizing return on capital. Therefore, finding ways to reduce the amount of buying power needed for a trade is of extreme benefit. Here, we will look at some ways tasty bite accounts can best maximize their available capital.
When talking about selling a straddle, we mean selling both the at-the-money (ATM) put and call. Selling a straddle will always bring in the greatest amount of premium. However, selling a straddle can require a lot of capital to trade in your account. In QQQ for example, a straddle will cost about $2,300 in a buying power reduction (BPR). For a tasty account, that may be too much capital in one trade.
One way to reduce the amount of buying power needed in this trade is to simply buy both an out-of-the-money (OTM) put and call. Essentially, what we are doing in this trade is selling an ATM straddle and buying an OTM strangle. This type of trade is commonly referred to as an “iron fly”, which you can trade in a single order.
In an iron fly, we want to keep as much premium as possible from selling the straddle. To do that while also reducing how much buying power is required, we look to buy the ten delta put and call. By turning a straddle into an iron fly, the buying power needed drops from $2,300 to about $585 or roughly one-quarter what was needed for selling a straddle. The slide below shows what our trade looks like when comparing a straddle to an iron fly.
Selling a covered call (or a buy-write) is another common trade. In a covered call, we sell one call for every one hundred shares of stock we purchase. This creates a position with a delta of 50 if you bought 100 shares of stock with 100 delta and sold the ATM call with negative 50 delta. For tasty bite (smaller) accounts, buying one hundred shares of stock may be too much capital for one trade. However, we can create a synthetic equivalent using just options.
Using EEM as an example, buying 100 shares then selling a covered call will require about $1,100 in buying power. A synthetic equivalent to this trade with the same delta exposure can be created by simply selling an ATM put. An ATM put, just like selling a covered call, has a delta of 50. However, where selling a covered call in EEM will cost about $1,100 in buying power, selling the ATM put requires just $650.
Selling premium in times of high IV is something discussed daily on tastytrade. All tastytraders should know that selling options in times of high implied volatility (IV) increases the amount of premium collected compared with time of lower IV and it also increases our probabilities of being profitable. Another benefit to high IV is we tend to see higher levels of return on capital (ROC) compared with BPR.
When IV is high we collect greater premium selling options. That means we are taking in more premium relative to the buying power being used in a trade. In other words, we are being paid more for risk.
All traders want to find ways to best maximize capital. For tasty bite accounts, it becomes even more important to efficiently leverage buying power in order to create enough occurrences so a portfolio is not jeopardized by one trade that moves beyond one standard deviation and that ROC is maximized.
Josh Fabian has been trading futures and derivatives for more than 25 years.
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