“It is always better to make little money most of the time than to make a lot of money once in a lifetime”

Market Neutral Strategies

These strategies are known as market neutral due to several key characteristics. Market neutral funds tend to take positions which offset each other through both a long and a short position simultaneously, in order to minimize their net position / exposure with respects to risk and return.

Long – Short:

Popular in times of uncertainty, a long-short methodology attempts to reduce market risk by taking both long and short positions in the market. This can be done by longing undervalued assets and shorting overvalued ones. If we consider what happens when the market goes up, the undervalued assets’ increase in value will likely offset the correction in overvalued assets. Hedge funds will hope that the spread between the gains and losses will be positive, i.e. the undervalued assets will see an increase in value greater than any losses incurred from the overvalued assets, or vice versa.

Convertible Arbitrage:

A seemingly complex strategy involving convertible securities (securities which can be exchanged for a predefined number of another) such as that of convertible bonds which convert into normal shares or bonds which is undertaken in order to take advantage of any price discrepancies between the convertible security and that of the exchangeable underlying. A position can be taken by longing the convertible security and shorting the underlying asset to which the convertible can be converted into in the hope that upon the conversion, there is a profit to be realized from the difference in prices.

Event Driven / Special Situations Strategies

As the strategy name suggests, event driven funds aim to profit on events related to particular companies. It is often said that these funds take a bet on direction rather than magnitude of move and play the game that something in the future will happen which will affect the company in a way which their assets move formidably. Although not limited to reorganizing firms and M & A participants, these are the primary strategies of event driven funds.

Distressed Securities:

An example of an event driven strategy is investing in distressed securities. These securities would include debt and equity of companies undergoing reorganization under Chapter 11 (in the USA), or are next to bankruptcy in the hope that the company will emerge from their positions and experience an increase in value. These securities often cost next to nothing and often give the hedge funds a position in the management of the company during the restructuring process; making them somewhat comparable to certain latter stage venture capitalists or even corporate vultures in certain respects.

Merger/Risk Arbitrage:

These funds tend to analyze companies which are potential takeover or merger targets by taking two positions. An example of this type of arbitrage would be buying a company’s stock which is a target for an acquisition as the value tends to increase upon the acquisition taking place and at the same time, short the acquiring company’s stock as the price of the acquirer will tend to fall in the even of an acquisition.

Long & Short

This category of strategies involves either buying or selling a particular security based on views of the market or the company. Often, a hedge fund will leverage their position to maximize any potential gains which may be realized.

Short Selling:

To profit from short selling, one would expect or hope that the price of a particular stock will fall at a future date. Hedge funds which utilize this particular strategy will often borrow stock to sell at market prices (shorting) and if the price falls, they will buy the lot back from the market at a lower price than they purchased it for and returning the borrowed stock to realize a profit.

Long:

A widely used strategy in hedge funds; this is merely an extension to standard equity-based investment funds in longing equities or other fixed income instruments in order to profit from a rise in the price of the held asset. The main difference is that whereas investment funds cannot take on leveraged positions, a hedge fund will often utilize leveraged positions to maximize returns.

Growth Fund:

Similar to long funds, these hedge funds aim to invest in growth stocks. This strategy seeks capital appreciation as its goal. Many of these portfolios are hedged by short selling and options.

Global Macro

Global Macro:

An economics based strategy, hedge funds utilizing this type of investment strategy aims to profit from shifts in global economic conditions such as inflation, interest rates, currencies and other macro-economic factors. Interest rate derivatives and currency derivatives are commonly employed for speculative purposes and are used to profit from economic movements in particular within particular countries.

Sector and Country

Sector Funds:

Hedge funds which have particular expertise within certain industries may focus on specific sector funds which invests in a particular sector such as technology, pharmaceuticals, utilities or any other market sector. These investments usually consist of long or short positions in the stock, debt or even derivatives on the sector stocks.

Emerging Markets:

These are funds focusing on emerging markets with less-developed economies and aim to profit from market growth or economic conditions which positively affect particular securities in the emerging market. Hedge funds which use this strategy will purchase securities in the emerging market such as sovereign debt or corporate securities in the belief that their value will appreciate with economic growth.

Dynamic Strategies

Market Timing:

As the name of the strategy suggests, this involves the appropriate timing of the markets. This type of strategy often aims to profit on the correct timing of investments across markets by moving between various asset classes depending on the managers’ view on the market environment.

Opportunistic:

Instead of merely switching across asset classes, these funds tend to make use of a combination of the aforementioned strategies depending on the managers’ outlook on the economy. The switching between strategies is an attempt to utilize the strategies which will give way to the most profitable opportunities.

Funds of Funds

Funds of Funds:

These funds invest in other hedge funds and can be seen as being a more diversified version of the normal hedge funds with the opportunity to take on hedge fund exposure, albeit not directly. These funds essentially analyses hedge fund manager performance and ability, rather than the actual investments within the individual hedge funds.

Funds of Funds of Funds:

A new concept developed by a New Jersey based hedge fund, funds of funds of funds (or F3s) aims to take on hedge fund exposure in terms of investable instruments whilst reducing the volatility of the fund itself. These F3s may allow investors with lower risk tolerances to take positions in the vastly mystifying hedge fund industry.

CTAs:

Otherwise known as Commodity Trading Advisors, these types of funds invest in financial and commodity futures markets. These funds are analogous to a standard mutual fund investing in equities, where instead of equities; the fund now invests in futures in an attempt to diversify futures positions to maximize the risk-reward profile. Traditionally, individual futures traders were exposed to significant risks when taking positions in futures contracts because of their low diversification and high transaction costs – CTAs are the result of the need for diversification into markets which an individual investor would otherwise find difficult to.

Under pressure from the financial industry, lawmakers cut an amendment that would have limited banks’ ownership in the clearinghouses to 20 percent. Instead, regulators can set the threshold — or not (a real possibility, given federal watchdogs’ deference to Big Finance in recent years).

This isn’t a mere technical detail. The arrangement would leave the five “broker-dealers” that dominate the derivatives market — Bank of America (BAC), Citigroup (C), Goldman Sachs (GS), JPMorgan Chase (JPM) and Morgan Stanley (MS) — with enormous influence over how quickly swap clearinghouses take shape, their operating rules and their efficacy.

The foxes wouldn’t be guarding the henhouse so much as renting it out. As bank analyst Chris Whalen, managing director of investor advisory firm Institutional Risk Analytics, recently told CNBC:

The OTC market — the monopoly — is increased by this legislation. [Sen. Chris] Dodd and [Rep. Barney] Frank are handing JPMorgan and the other big guys who can interface in a clearing environment the keys to the kingdom.

Why should we worry if Wall Street controls clearinghouses? For one, they have a financial interest in seeing them fail, since flourishing exchanges would push banks to the sideline in the enormously lucrative swaps business. Second, banks could be tempted to lower the standards for using the exchanges, such as margin requirements, to deter derivative buyers from using competing clearinghouses.

Wallace Turbeville, a former Goldman VP who now blogs for a centrist think-tank, notes that banks historically have sought to control the underlying structures where trading occurs. And he warns against allowing Wall Street to extend that dominance to clearinghouses:

It has never been more important to secure the independence of market infrastructure from the banks. With regulatory reform in place, the ability to avoid its intended purpose by influencing the mechanisms of the market to enlarge gaps in regulation will be a central goal of the financial institutions. They must be told that the infrastructure is not theirs to use to avoid regulatory control.

Third, and perhaps most troubling, allowing banks to control clearinghouses undermines their basic premise — reducing the chances of an AIG-like systemic collapse if a big derivatives user blows up. Along with excessive leverage, a major reason financial markets seized up in 2007 was the degree to which “too big to fail” firms were interconnected. Linking a handful of big banks through common ownership of a swaps clearinghouse increases, not reduces, those connections, which in turn concentrates risk.

As the reform bill moves ahead, one thing to look at is whether regulators ultimately force banks to open up existing clearinghouses. Wall Street firms last year joined with IntercontinentalExchange (ICE) to launch a clearinghouse for OTC derivatives. The banks effectively bar smaller broker-dealers from joining the clearinghouse by requiring them to have a swaps desk or have a net tangible worth of least $5 billion.

ICE Trust, as the clearinghouse is called, is effectively an oligopoly. The company’s owners — Wall Street — can use that market power to slow down the transition to central clearing. As Robert Litan, a fellow at The Brookings Institution, put it in an April report:

[A]s long as ICE Trust has a monopoly in clearing, watch for the dealers to limit the expansion of the products that are centrally cleared, and to create barriers to electronic trading and smaller dealers making competitive markets in cleared products.

Other key market players involved in derivatives trading also are largely controlled by big banks. The Depository Trust Clearing Corp., the main source of credit default swap data, serves at the pleasure of its bank customers. And Markit, the chief provider of pricing info for derivatives, is owned by a several Wall Street banks, including JPMorgan Chase and B of A. Says Litan:

Pricing data is the “oxygen” that enables financial markets to thrive. As long as these data are controlled by the entities whose economic interest is to slow constructive reform, then users of derivatives will continue to trade with less information than is now routinely available to participants in markets for stocks and futures, especially as long as many derivatives can be kept off exchanges.

The financial reform bill was deeply flawed. But one thing it got right was ordering the use of swaps clearinghouses, a crucial step in lighting up the “shadow banking system.” It would be boneheaded — and dangerous to the financial system — to entrust the future of those exchanges to firms with an interest in exploiting them for their own ends.

The cone compresses as we show longer periods of time

What this cone is telling us is that over longer option horizons we should feel comfortable selling anything with an implied volatility greater than 35% and buying anything at an implied volatility in the single digits. What we also see is that there is not a big discrepancy between most of these tenors except for when you get into the tail events. This is mostly due to the law of large numbers where the 30 day percentiles converge towards the longer term percentiles.

This means that for trading purposes a shorter time frame is more useful. In a refinement, let’s look at the last 5 years instead of the last 80.

A much more visible cone shape in 5 years

The last 5 years of data shows us a greater dispersion between tenors. We witnessed 1-month periods of 80% realized volatility while we realized one year periods of just half that. Volatility cones are by all means not perfect indicators as the future is always an unknown, but being able to plot current implied volatility levels against these historical metrics provides one basis for coming up with a trade idea.

All this hype, though, means that there is a trade to be had. I’d like to highlight some option ideas available directly to the retail investor involving the exchange-traded fund CYB, which through currency swap agreements tracks the value of the RMB.

Trade 1: Sell $25 put for any date

This trade works regardless of whether or not you believe China will appreciate its currency. As the financial crisis has subsided, CYB has traded in a tight range, $25.60 to $25.20, and it is highly unlikely that CYB will fall below $25. In its short trading history, CYB has only fallen below that level 3 times, which were during the heart of the financial crisis. Barring any unforeseen worldwide financial meltdowns, it is safe to assume that CYB will not pierce the $25 mark as it is highly unlikely that China will devalue its currency. Also, because China keeps it currency pegged, the absence of action by China on its currency will keep CYB’s value constant.

Even if there is a financial meltdown and CYB drops substantially below its NAV, the loss is minimal. Assuming that you sold a July 25 put and received .25 per share (bid ask midpoint at time of writing) and that CYB reached its 52 week low, $24.57, you would only lose $.18 (in addition to the lost premium) per share if your put was called and you immediately sold your shares back on the market.

Trade 2: Buy July $21 Call

While it may seem awkward to buy such a deep in the money call, this is the most effective way to gain leverage from options while paying a minimal premium. If China revalues its currency during the April-May window, you stand to gain a good return on your investment. If China does not revalue its currency the contract still has strong intrinsic value. Assuming that you buy the contract at $4.25 per share (bid ask midpoint at time of writing), you stand to lose very little because CYB will deviate very little from its current price, $25.25.

Straight up teaching/mentor relationship beyond compare.

It’s been said that when the student is ready, the teacher arrives. Dale arrived for me just under one year ago. I had been looking for a system and method of options trading that would fit me and not encumber the process with layers of complexity. Dale’s system does just that. If you are not familiar with him, he is an innovator and, as a result, a very successful options trader; but beyond those two important attributes, Dale is a marvelous teacher. I’ve only experienced two excellent teachers in my life. The first was over 30 years ago while studying architecture in college. Dale is the second. Both share the gift of showing you the path and then letting you grow into the right answer for you. Dale’s system cannot be better for anyone desiring to learn and trade options successfully. Others can attest to that. The system is amazingly simple, yet does require commitment and focus to produce consistent results. What truly makes him remarkable is his enthusiasm and love for teaching what he himself has discovered from his 25 years of experience. It’s also been said that the mind, once expanded to the dimensions of larger ideas, never returns to its original size. I encourage you to try Dale’s teaching, but beware, you may find that you cannot go back the way you came. In my experience, that is a very good thing.

The most accurate method i have ever seen

I have been following Dale for just over one year. He really has found a method that is 100% accurate in predicting the movement of stocks or any other commodity that can be tracked with a MACD. In fact in the year I have never seen him be wrong once. He has given away many 500 to1000% winners. But that is not his purpose. His purpose is to teach us how to do it ourselves. This is not a program that tells you what to buy or sell. It teaches us how to determine that ourselves down to the moment to transact. It is simply amazing but based on simple Newtonian physics. It looks simple and your emotional conditioning may make it hard to believe or accept but it is real.

Dale has really discovered how to observe teh underlying forces that move the market. Using Divergences of MACD and price on different time frames and cooborrating with other factors you can really pick huge winners. Even though it is simple it soes seem to take a year or two to get it, and people who have stuck to it and studied hard are making big money consistently.

Excellent options trading strategy

I have looked at many trading strategies over the past 20+ years and can say this strategy is absolutely the best I’ve seen. I like it because it is not a black box plan. I can actually look at the chart and using the trading knowledge he teaches, I can understand what will happen to price. I would not yet consider myself a successful trader using the system but I’m confident that I will become one. I’ve been in the classes for 2 years and do not plan to quit now. People who have prior trading knowledge will have to forget a lot of what they think they know about trading to effectively use the strategy because it is a different interpretation of technical indicators. I am absolutely satisfied with Dale’s teaching of the method.

Not all optionable underlyings have LEAPS, but most of the current ones that do have January 2011 and January 2012 expirations. (Some exchange-traded funds are exceptions.)

Most traders stick to the front-month expiration when they are trading options, as that is where you get the biggest “bang for the buck.” Volatility traders often do the same, as volatility “mispricing” tends to be where the volume is.

For instance, if we recently looked at the 20-day average volume for the S&P 500 SPDR (SPY) and found more than 900,000 contracts average in the February expiration, 300,000 in March, and nothing else above 50,000. In Bank of America (BAC), the top name in equity options in one recent session, we saw 176,000 in February and 50,000 in March.

But recent sessions have provided some interesting trades that give an indication of the appeal of LEAPS. On Feb. 17 we saw one trade that sold 5,000 of the EMC Corp. (EMC) January 2012 20 calls. A few days earlier another sold 10,000 of the Ford (F) January 2012 10 puts. The call selling is likely done against long stock as a covered call position.

Covered calls are the most common options strategy, and naked call selling has unlimited risk potential. So advanced traders will see that the above two positions are virtually identical, as a covered call and short puts have the same risk profile.

Those Ford puts were sold for $2.25. This means that the trader collects $2.25, which was 20 percent of the stock’s closing price. The trade is protected down to $7.75, as that is the downside break-even point, the price below which the trade would show a loss at expiration. That is 30 percent below the stock’s price.

A 20 percent return–assuming that Ford is above $10 come January 2012–may not sound like much over roughly two years, but most institutional investors would probably jump at that prospect. If shares move higher in the near term, that position will likely be closed out earlier with a better relative return.

Another use of LEAPS is as stock substitutes. Some traders don’t like options because of the need for continual rolls to maintain a position. Using LEAPS eliminates such a need.

LEAPS also have relatively low time decay. In-the-money calls tend to have low time premium, even out a year or two. So some traders buy them instead of being long (or short) stocks, as the capital outlay is less.

This disruption did have one positive outcome: It taught market participants a critical lesson about the importance of developing a more robust approach to assessing risk and value in portfolios.

Nearly every investor we’ve spoken with over the past year agrees there is a need for change in the discipline of credit and risk valuation as it relates specifically to price and price risk. At the same time, however, it has been difficult to coalesce all of the pieces necessary to deliver truly comprehensive methods for security and portfolio valuation. This is the next step the market needs to take.

A Multi-Model Credit Discipline

To get to that point, we need new and innovative methods of analysis that build on the lessons of the crisis and clearly identify the relationship between risk and asset price for all credits in all types of market conditions. Investors need to be able to easily deploy an analytic discipline that moves beyond traditional notions of risk management, static benchmarking and probability of default metrics in order to incorporate a comprehensive, cross-asset view of credit quality.

What we learned from the experience of the last year is that the vital risk assessment process is an evolutionary one that must address the dynamic nature of change that accompanies rapidly evolving financial markets and products.

Sophisticated investors are now demanding a reliable cross-asset, cross market perspective that incorporates those components of risk that drive changes in market valuation. Included in this view should be an understanding of an asset’s risk to price, capital structure issues, volatility, liquidity and more.

Risk to Price

Dozens of variables have direct and indirect impacts on asset prices: probability of default, loss recovery, interest rate risk, liquidity and volatility, to name a few. When these variables start moving in different directions, asset price is going to be impacted. It all boils down to a basic question: does a bond’s yield adequately compensate its owner for the credit and market risks being faced? Often, traditional analysis does not provide a sufficiently clear answer to that question. Accordingly, we have been working on a scoring methodology designed to assist investors in determining the extent that a bond’s yield is commensurate with the risks it incorporates.

Investors need to be able to quickly and accurately identify the scope of these impacts under many different market conditions. By developing methods to evaluate the price of an asset relative to variables that incorporate both market and credit risk, it is possible to determine gaps in risk to price and, therefore, spot potential mispricing.

Market Derived Signals

In addition to monitoring credit ratings, it is crucial for investors to use models that incorporate the prices of Credit Default Swap (CDS) contracts to capture the market’s sentiment regarding a company’s perceived credit risk. By regularly measuring that sentiment against the ratings, it is possible to spot deviations in market sentiment that may have a bearing on an investment decision.

For example, over the past year, McDonald’s Corp.’s credit default swaps have maintained strength relative to its peer group, indicating a market-derived rating of “aa+” versus its corporate credit rating of “A.” This reflects a positive market sentiment that clearly has a bearing on credit price. Investors need to factor this kind of intelligence into their portfolio analysis and valuation.

Capital Structure Analysis

Investors also need much deeper insight into smaller, non-public, and/or un-rated firms that could pose substantial counterparty risks to a portfolio. This kind of due diligence cannot be treated as a sideline initiative; it needs to be integrated into the portfolio analysis workflow so investors can incorporate revenue health, operational health and liquidity into all investment analyses.

Only by evaluating the entire capital structure of their holdings will investors be able to truly understand the full risk profile of their securities from a multi-dimensional perspective.

Credit Research May Only Be One Component—But It’s A Critical One

It is not enough to just throw a bunch of new analytics at the problem; investors also need to be able to analyze and deploy this information strategically. The practice of ongoing, cross-content and cross-asset class research and analysis that incorporates all available risk models needs to become de rigueur in the credit markets, and data and analytics companies need help investors meet this need by providing the resources and commentary they need to scrutinize their underlying assets.

The days of following gut instinct and relying on one or two data points to back it up are gone. Proof of price is the new Holy Grail for credit investors. To demonstrate that proof, a new level of rigorous analysis is required – one that acknowledges the lessons learned in the crisis to restore the investor appetite for calculated risk and improve the health of the financial markets.

What Has To Be Done

The type of change requires a transformational effort on the parts of investors, originators, risk managers and information and analytics companies. Fortunately, the upside potential for all stakeholders associated with this analytic innovation is enormous, while the downside risk is nonexistent. In a world with so few sure things, we like the odds of success for an investment in better investor education. There is a very clear path to restoring liquidity to the fixed income markets; those who lead the way will be the firms who act now to up the ante on analysis and valuation.

Lou Eccleston is Executive Managing Director Standard & Poor’s Fixed Income Risk Management Services (FIRMS), an analytics and research unit separate from S&P’s ratings business that delivers solutions to help investors perform greater analysis on the financial instruments in their portfolios.

For example, the PowerOptionsApplied Chromium TradeFolio ^TM was considering the following iron condor trade on 8/28/2009 for the SPX index:

The market prices of the options for this iron condor would be the ask price for the two long stock options and the bid price for the two short stock options.

So the market net credit for this iron condor is calculated as:

The market net credit is a negative -$0.05 so entering the position with this net credit would guarantee a loss.

But what if it were possible to get better than market? What if it were possible to get prices midway between the bid/ask spread, for example?

The stock option prices calculated with the midway between bid/ask is shown in the table below:

The calculation of the midway between bid/ask net credit is calculated as:

The $0.45 midway net credit represents a potential return of 4.7%. The 4.7% potential return is calculated as shown below:

Since this iron condor has an equal spread differential 920-910=1135-1125 (short put strike – long put strike) = (long call strike - short callstrike) and the same month of expiration, September, the iron condorqualifies for special margin. This means the iron condor only requires half the margin of a standard iron condor. Not all brokers support special margin for iron condors, so traders wanting special margin consideration should verify their broker of choice supports special margin.

iron condor would have a return calculated as:

The special case iron condor has a potential return that is twice the return of the standard iron condor. Trading iron condors with special margin consideration is well worth it.

iron condor trade was entered with a net credit of $0.40 which was a little less than the midway net credit of $0.45. The $0.40 net credit represents a potential return of 4.2%, slightly less than the midway between bid/ask return of 4.7%.

The actual fill prices were very close to the midway between bid/ask prices shown earlier.

For option investors with a lot of time and patience, the net credit can be squeezed even more. For this case, the initial net credit could have been entered at $0.50, for example, and then gradually decreased until the trade executed.

To calculate the maximum net credit possible, just reverse the bid/ask for the market net credit as shown earlier:

It would have been a waste of time to enter a trade for greater than the maximum net credit of $0.95 as it would not have executed.

Stock options traders with a LOT of time on their hands could even enter the stock options trade at $0.95 and gradually decrease the net credit until the position executes.

But experience has shown that option trades will often fill at prices near the midway point between the bid/ask prices.

It really is possible to squeeze money out of the stock options market, all that is needed is a little effort and a little patience.

In general, short sellers of a stock have to close or buy back the stock they shorted at some point. There are the cases where the company goes bankrupt and the stock ceases to trade anymore, but in most cases short sellers have to exit.

Strangely, when more short sellers are exiting than are entering the price of the stock may actually goes up, even though there may not be any investors purchasing the stock for a long investment. So here’s this dog-with-fleas company that is not doing so hot, yet it’s stock price is going up due to the short sellers buying the stock in order to exit their positions.

This phenomena where short sellers are exiting and the price of a stock is going up is commonly referred to as a short squeeze. Once the short squeeze begins, it often can become self-fulfilling, as the higher the stock price climbs, the more short sellers will decide they want to exit their positions, or be required to exit their positions if they receive a margin call.

Days-to-Cover refers to the number of days required, based on average daily volume, to purchase the total number of shorted shares.A common method for detecting a short squeezed stock is to look for stocks of companies that have high short interest and also have low volume. A good parameter for finding a short squeezed stock is to examine the Days-to-Cover or Number-of-Days-of-Short-Interest.

For example, if a million shares of a stock are shorted and the average daily stock volume is one million, then the value of Days-to-Cover is 1 day.

In searching for a short squeeze condition, the larger the value of Days-to-Cover, the larger the potential for a short squeeze.

A company whose stock is being short squeezed is unlikely to go down, so the short squeeze provides a bottom for the stock’s price or acts like an artificial put option for protecting the position from a further drop in price.

Using PowerOptions powerful search engine, a search was made for stock’s of companies which appeared to be in a short squeeze and also had a nice return for a covered call investing position. A covered call investingposition combined with a stock which has a bottom makes for a position with a high probability for return.
Number-of-Days-Short-Interest (Days-to-Cover) > than 30 daysThe parameters used for the search were:

Simple 50-day Moving Average(SMA50) > than Simple 100-day Moving Average(SMA100)

Price-to-Earnings (P/E) > than 0

Covered Call Potential Return > 2%

The idea behind these parameters was to find profitable companies, P/E greater than 0, with attractive covered call positions, Covered Call Potential Return greater than 2%, whose stock price was in an uptrend, SMA50 greater than the SMA100, and whose stock was in a short squeeze, Days-to-Cover greater than 30 days.

With the higher short interest, Bank of the Ozarks appears to be the best candidate of the two companies.After performing the search, a couple of companies popped up on the radar, Bank of the Ozarks (OZRK) and Ritchie Brothers Auctioneers (RBA). Of the two companies OZRK’s short interest of 27% was greater than RBA’s short interest of 14%.

Bank of the Ozarks provides retail and commercial banking products and services. Apparently the short investors thought Bank of the Ozarks would go bankrupt like a lot of other banks did during the economic recession. But in its recent earnings report, Bank of the Ozarks appears to have faired the economic recession in good order.

OZRK’s stock price has been in a trading range between $20 and $26 over the last several months and is currently situated near the middle of that range.

A covered call investing position for OZRK for November looks interesting with a potential return of 3%. The position of interest to sell for a covered call investing position is the November 22.50 call option with ticker symbol OWIKX.

To enter the covered call investing position an investor would purchase the stocks in multiples of 100 shares for their trading portfolio and sell one call option for each 100 shares of stock purchased for their personal stock portfolio.

The Double Diagonal is a neutral stock options strategy. The Double Diagonal strategy is similar to an Iron Condor and can be considered a combination of a Calendar Call spread and a Calendar Put spread.

The Calendar Put spread portion of the Double Diagonal is entered by selling an out-of-the-money put option and purchasing a further out-of-the-money put option having an option expiration further out in time.

The Calendar Call spread portion of the Double Diagonal is entered by selling an out-of-the-money call option and purchasing a further out-of-the-money call option having an expiration further out in time.

Another way to look at a Double Diagonal is an Iron Condor which has been “diagonalized”.

Advantages of a Double Diagonal over an Iron Condor:

Potentially lower brokerage fees and commissions
Increase in volatility increases attractiveness of position
Increased profit potential at short put option and call option strike
Less risk/smaller potential losses with wider breakeven range
Similar NDX Iron Condor and Double Diagonal positions will be analyzed in order to illustrate the differences between the two strategies.

The NDX Iron Condor position selected to be analyzed is shown below:

Buy 10 contracts of $NDX 2010 MAR 1,600.00 PUT @ $4.20 $4,200.00

Sell 10 contracts of $NDX 2010 MAR 1,625.00 PUT @ $4.90 ($4,900.00)

Sell 10 contracts of $NDX 2010 MAR 1,950.00 CALL @ $1.45 ($1,450.00)

Buy 10 contracts of $NDX 2010 MAR 1,975.00 CALL @ $1.00 $1,000.00

The NDX Double Diagonal position selected to be analyzed is shown below:

Buy 1 contract of $NDX 2010 APR 1,475.00 PUT @ $4.10 $410.00

Sell 1 contract of $NDX 2010 MAR 1,625.00 PUT @ $4.90 ($490.00)

Sell 1 contract of $NDX 2010 MAR 1,950.00 CALL @ $1.45 ($145.00)

Buy 1 contract of $NDX 2010 APR 2,050.00 CALL @ $0.70 $70.00

The short put options and short call options are identical for the two positions with the long options having different months of expiration. The long options for the Iron Condor position have a month of expiration of March and the month of option expiration for the Double Diagonal long options are in April.

Brokerage Fees & Commissions

For this example, the Iron Condor position was entered with 10 contracts, whereas a similar Double Diagonal position was entered with only 1 contract. An investor may be able to realize reduced brokerage fees and commissions when investing with the Double Diagonal over the Iron Condor.

Volatility

The long options for the Double Diagonal being further out in time than for the Iron Condor presents a nice advantage for the Double Diagonal over the Iron Condor with respect to an increase in volatility. An increase in volatility will have a larger impact on the long options for the Double Diagonal than for the long options for the Iron Condor. An increase in volatility will cause the value of the long options for the Double Diagonal to increase more than the respective long options for the Iron Condor resulting in increased profitability for the Double Diagonal. Additionally, the increased sensitivity of the Double Diagonal to volatility spikes results in smaller losses for the Double Diagonal when exiting a position due to a stop-loss.

Capital Requirement and Special Margin

The capital requirement for both positions is about $24,000 with potential returns in the 4.5% to 4.8% range. The Iron Condor position can take advantage of special margin since the difference between the put spread and call spread is the same (25) and the month of expiration for all of the options is the same (March). Since the Iron Condor can only suffer a loss for either the put spread or the call spread, some brokers allow for special margin for Iron Condors if the months of expiration for all the options the same and the put and call spread differentials are identical. Conversely, the Double Diagonal position does not qualify for special margin since the month of option expiration for all options is not the same. For the Double Diagonal, the month of expiration for the short options is March and the month of expiration for the long options is April.

The profit and loss charts for a similar NDX Iron Condor and NDX Double Diagonal position for expiration in March of 2010 are shown below:

Breakeven – Iron Condor vs. Double Diagonal

The lower break-even price of $1,612 for the Double Diagonal is smaller and more advantageous than the larger break-even price of $1,624 for the Iron Condor. Similarly, the upper break-even price of $1,957 for the Double Diagonal is higher and more advantageous than the break-even price of $1,951 for the Iron Condor.

Loss of Capital

Since the Iron Condor position takes advantage of special margin, the position can realize a total loss of capital if the price of NDX closes below the short put strike of 1,600 or above the long call strike of 1,975 at option expiration. In contrast, the Double Diagonal does not qualify for special margin and the largest loss the Double Diagonal can suffer is about 50% which occurs if the price of NDX closes below $1,475 or above $2,050 at option expiration.

The break-even prices for the Double Diagonal are more advantageous than for the Iron Condor, but the difference is really pretty small, less than 1%. However, the differences for the prices of maximum capital loss are significantly better for the Double Diagonal than the Iron Condor, on the order of 4% to 8%.

Advantages Summarized

To summarize, the Double Diagonal position has a similar return as the Iron Condor with less risk. At this point, the Double Diagonal appears to a better strategy than the Iron Condor, however, the Double Diagonal does have some disadvantages when compared to the Iron Condor.

Disadvantages of a Double Diagonal compared to an Iron Condor:

Special margin not available
Decreased profit potential near midway point between option short strikes
Return calculation is not straightforward
May require significant capital for implementing with indexes
Double Diagonal – No Special Margin

As discussed earlier, the Double Diagonal cannot take advantage of special margin as in the case of the Iron Condor. The Iron Condor can basically generate twice the return of the Double Diagonal for a given amount of capital invested.

Iron Condor Profitability Region

As can be observed from the profit/loss charts, the Iron Condor has a very uniform profitability region between the short option strike prices with a very sudden drop off in profitability (or loss) with underlying prices lower than the short put strike price or higher than the short call strike price.

Double Diagonal Profitability Region

In contract, the Double Diagonal experiences the most profit when the price of the underlying is near one of the short option strike prices at expiration. Additionally, and in contrast to the Iron Condor, the profitability of the Double Diagonal is not uniform between the short option strike prices and dips or drops near the midway point between the short options.

Straightforward Potential Return Calculation

For the Iron Condor, the potential return calculation assumes all of the Iron Condor options will expire worthless, so the calculation is very straightforward. However, since the short options for the Double Diagonal have a shorter timeframe for expiration, the potential return calculation is more complicated, as the price of the long options have to be calculated or estimated in some manner. This calculation is generally performed using the Black-Scholes option pricing model which is somewhat complicated and will not be discussed in this article.

Capital Requirement and Tax Advantages

For the example NDX positions selected, the minimum amount (one contract) that could be invested with the Double Diagonal was about $25,000, whereas the Iron Condor could be entered with a capital requirement (one contract) of about $2,500. Alternatively, a similar Double Diagonal position with a smaller capital requirement could have been entered for the QQQQ ETF. However, a Double Diagonal for an ETF would not be subject to some of the tax advantages available for a Double Diagonal position with an index as the underlying. More information is available for the tax advantages of Broad-based Index Options at this website: Tax Advantage.

Summary

The Double Diagonal strategy is a very powerful and flexible stock options strategy. The strategy is a neutral strategy with the potential to work in low volatile markets while providing an attractive risk/reward profile.