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  1. 1. January 2006 Volume 2, No. 1 • MAX ANSBACHER ON SHORTING OPTIONS The Options Trader interview • CALL WRITING FOR STOCK INVESTORS: Low-cost portfolio insurance • THE OPTION SELLING ALTERNATIVE: Covered combos • STRATEGY ANALYSIS: Option volume trade signals • TRADE DIARY: S&P bear call spread
  2. 2. CONTENTS Options Trader Interview . . . . . . . . . . . .8 Max Ansbacher: The options seller Money manager Max Ansbacher describes the nuances of selling options and how this approach has helped him outperform the market since 1995. By David Bukey Trading Strategies . . . . . . . . . . . . . . . . . .14 The out-of-the-money advantage A put-buying strategy to cope with a nervous stock market. By Keith Schap Options Strategy Lab . . . . . . . . . . . . . . .18 Trading on unusual call activity New Products/Events . . . . . . . . . . . . . . .19 Trading Basics . . . . . . . . . . . . . . . . . . . . . .20 The option-selling alternative Contributors . . . . . . . . . . . . . . . . . . . . . . . . . .4 Comparing three short option techniques — uncovered puts, covered calls, and covered Options News combos — shows ways to gain an edge when Considering the options buying or selling the underlying instrument. for the future(s) . . . . . . . . . . . . . . . . . . . . . . .6 By Bill Ryan Although an SEC-CFTC merger is highly unlikely, a multi-asset class Options Trade Journal . . . . . . . . . . . . . .24 exchange might not be too far off. S&P 500 bear call spread Putting on a bear call spread in S&P 500 CBOE, ISE keep rolling . . . . . . . . . . . . . . . . .6 options. The Chicago Board Options Exchange and the International Securities Exchange both Key Concepts . . . . . . . . . . . . . . . . . . . . . . .26 had good news in December that had nothing to do with trading volume. Options Expiration Calendar . . . . . . .28 Have a question about something you’ve seen in Options Trader? Submit your editorial queries or comments to For how-to instruction on viewing the magazine visit Looking for an advertiser? Click on the company name below for a direct link to the ad in this month’s issue of Options Trader. OptionVue CBOE Risk Management Conference CBOE ChoiceTrade 2 January 2006 • OPTIONS TRADER
  3. 3. OPTIONS TRADER INTERVIEW Max Ansbacher: The options seller Max Ansbacher has been selling options for more than 30 years and runs a multi-million-dollar option fund with an impressive track record. We spoke with him about his market experience and why he thinks his fund’s option-selling strategy continues to have an edge. BY DAVID BUKEY I n the early 70s Max Ansbacher was a successful attorney working for Colgate Palmolive when listed options were introduced by the Chicago Board Options Exchange (CBOE). When his broker sug- gested selling some covered calls on stocks he owned, he was surprised when the calls all made money as they expired worthless. now manages more than $171 million and has been prof- itable nine of the past 10 years, including a 94.93-percent gain in 1997, the largest net return of any Commodity Trading Advisor that year. While Ansbacher has refined his approach over the years and is quick to recognize the risk of selling naked options, he maintains that premium sellers have a market edge in The only problem was Ansbacher’s stock was plummet- various market conditions. ing at the same time because he began selling options at the outset of the 1973-74 bear market. But once he started sell- OT: You began selling calls in the early 70s and have con- ing uncovered calls, he was hooked. tinued to sell options throughout your career. Do you still “It was a money machine for two reasons,” he says. advise against buying options? “Option prices were probably five times higher than they MA: Options are much less expensive than 30 years ago. I are now. And it was also a bear market, so if you sell over- wrote in The New Options Market that you can’t make money priced calls, how can you go wrong?” buying options. Today you could if you happened to be After his initial success, Ansbacher began researching right. However, option writers make money for some very options but couldn’t find relevant books on the subject. At the solid reasons. time, option trading books focused on the over-the-counter market, so Ansbacher wrote the first book on listed options — OT: Which are? The New Options Market, originally published in 1975. MA: They have capital and are entitled to a return like any Ansbacher then left his 15-year law career to work as a business. A businessman has capital and puts it at risk in broker at Bear Stearns for the next 20 years. Meanwhile, he hopes of making a profit. Option writers provide a financial continued to write options and wrote two more books — product to the world because when you short an option, How to Profit from the Coming Bull Market (Prentice Hall, you’re creating it. 1981) and The New Stock-Index Market (Walker & Co., 1983). He also developed the Ansbacher Index, a market senti- OT: Was it easier to find overpriced options at the begin- ment indicator that compares the prices of out-of-the- ning of exchange-traded options in the 70s than it is now? money (OTM) puts and OTM calls on the S&P 100 (OEX) MA: Absolutely. and S&P 500 indices (see “The Ansbacher Index,” Active Trader, February 2002). It is a contrarian indicator designed OT: Why? to supplement the put-call ratio, which tracks only option MA: Options started out at very high prices because so volume. many brokers recommended their clients buy calls instead Ansbacher launched his own option-trading fund, of stocks. Ansbacher Investment Management, in 1995. The fund There was quite a bull market going into that 1973-74 8 January 2006 • OPTIONS TRADER
  4. 4. FIGURE 1 — YEARLY PERFORMANCE — 1995 TO 2005 Ansbacher outperformed the CSFB/Tremont Hedge Fund Index in eight of the past 10 years, including each of the past three years. His outstanding gain in 1997 (94.93 percent) made him the top-performing CTA that year. period. Brokers said “You can buy Avon Products for $130 or you can buy a call for $10. If the stock goes up a lot, you’ll make just as much money on the call as you would in the stock. If it goes down, your call will only lose $10, the stock could lose $130.” Pretty easy decision — buy the option. (Laughs.) Of course, now we know they should be worth much less than they were then. OT: What’s your fund’s strategy? MA: We sell options on the S&P 500 and also on 10-year and 30-year U.S. treas- ury futures. OT: Why those markets? MA: First, we needed a macroeconomic Source:; index for liquidity, which is very impor- tant to us since our fund [now manages FIGURE 2 — ANSBACHER VS. S&P 500 more than $171 million]. The market makers in those markets can step up and buy 1,500 or A $1,000 investment in Ansbacher’s option-selling fund in May 1994 3,000 options at a time. Also, the S&P 500 is not would have returned $9,580.76 within 10 years — nearly three times as much as the S&P 500. nearly as volatile as the individual stocks that make it up. When you buy an index, it auto- matically takes out a lot of the volatility. OT: Do you trade options on S&P futures rather than index options themselves, and if so, why? MA: Yes. The margins are lower, and you don’t want to get a margin call if something gets a lit- tle bit out of whack. OT: Is it fair to say that your strategy is basi- cally selling volatility? MA: I don’t know if we’re selling volatility. We like to think we’re selling time value. OT: Do you take a market direction or are you solely focused on taking premium out of the market? MA: We’re a market-neutral fund. And our results have had very little volatility over the last three years (see Figures 1 and 2). Source: OT: So it’s not as simple as selling more puts in an uptrend or selling more calls in a downtrend? OT: So how do you find overpriced options? MA: If identifying an uptrend or downtrend were that easy, MA: That’s an interesting question. You assume we do find then we could trade S&P futures and do very well, right? continued on p. 10 OPTIONS TRADER • January 2006 9
  5. 5. OPTIONS TRADER INTERVIEW continued The Ansbacher Index T he Ansbacher Index (AI) is an indicator based on the prices of index options designed to gauge the sentiment of options traders. AI read- ings can be used to measure the current level of bullish/bearish sentiment, forecast the future direction of the stock market, and decide whether to use long or short option strategies. Extreme AI readings indicate overpriced options. But that’s not one potential reversals of the current price trend. of the most important things. We want The AI offers a different way to measure market sentiment by comparing to be in the market all the time. We’re the prices of calls and puts rather than the number of calls and puts (as does looking for a certain delta, so we’re the put-call ratio). The indicator compares Standard & Poor’s 100 Index (OEX) usually in the near-month contract or call prices to put prices — specifically, the price of a call approximately 40 points the next one out. above the current OEX price divided by the price of a put the same amount below the OEX price. OT: So your time frame is less than When traders become optimistic, they will tend to aggressively bid for calls, eight weeks? especially out-of-the money calls. This demand for calls can drive the price of MA: Right. This isn’t always the case, calls relative to puts to extreme levels — an indication of the bullish senti- though. ment. On the other hand, if the majority of traders are pessimistic, they will purchase puts. The price of puts will climb relative to the price of calls, a OT: Are you looking for strike prices reflection of bearish sentiment. that are a certain percentage above and below the current price? Interpreting the index MA: No. If the market’s extremely The higher the price of the put compared to the price of the call, the lower the volatile, you might want to be 15 per- AI will be. For example, if a put were 2 and the call were 1, the index would centage points out of the money. But be 0.5. If the put and call were equal, the index would be 1.0, and if the put if the market’s flat as a pancake, the were 1 and the call 2, the index would be 2.0. VIX would drop, and you couldn’t get At first glance, a 1.0 reading would seem to be the theoretical neutral level any money for those. Second, you for the index. However, in the real world the neutral level ranges between wouldn’t need to sell options that far 0.70 to 0.90 because many stock owners are natural buyers of puts (to hedge out of the money. In the last year or so, their positions). Also, many investors sell calls against their portfolio to it’s been a rather non-volatile market. increase their yields. So you don’t have to sell strike prices These two factors account for the downward shift in AI readings. As a so far out. result, an index reading less than 0.70 is regarded as bullish for the stock market, with the degree of bullishness climbing as the value of the index OT: Many traders compare a market’s decreases. An index level greater than 0.90 is bearish, with the level of bear- implied volatility and its statistical, or ishness increasing as the index moves higher. Thus, the more people are will- historical, volatility and then trade ing to pay for puts (which is a way of indicating they are bearish), the lower based on extreme divergences — (more bullish) the index reading. buying historical lows and selling As its levels imply, the AI is a contrarian sentiment indicator. The basis of con- unusual highs. What do you think of trarian theory is that when most people are very bullish the stock market is likely this approach? to go down, and when most participants are very bearish the market is likely to MA: We look at the difference go up. When traders or investors are extremely bullish, they already have pur- between implied and actual volatility. chased all the stock and call options they are likely to buy. Therefore, there is no As you may know, the implied is sig- longer future potential buying power and there is little demand left to push prices nificantly above actual [volatility lev- higher. If the market turns down, the amount of selling will rise, as many of these els], especially in S&P puts. This is investors will change their opinions and liquidate positions, intensifying the down- where we have our edge. turn. The opposite is true when most investors and traders are very bearish. For example, if the Black-Scholes While extreme AI readings are rare, they provide a qualitative perspective pricing model shows S&P options to the current sentiment of options players. For example, if the market is in a should cost $3, but they cost $3.75, that downtrend and AI readings are hovering near 0.70 (despite the reading being $0.75 is what option buyers are willing on the lower side of neutral), you can conclude that options traders are more to pay. It’s also the profit margin that bullish than one would expect given the market’s bearish condition. option writers insist on before they sell — Excerpted from “The Ansbacher Index,” Active Trader, February 2002. You can them. Our strategy is inherently prof- purchase past articles at and down- itable because options are priced high- load them to your computer. er than they theoretically should be, 10 January 2006 • OPTIONS TRADER
  6. 6. especially puts. those stops. We wouldn’t want to get * stopped out on the side that didn’t At ChoiceTrade OT: Nassim Nicholas Taleb, author of have much short option value. If we we are all about "Choices" Fooled by Randomness, takes the have a lot, we’ll [tighten] them. Also, opposite approach. He buys OTM as we get closer to expiration, we want Choices in products, service and price. options instead of selling them, to tighten stops because the gamma because he argues it’s better to pay increases as expiration approaches. small amounts waiting for an inevitable EQUITY TRADES rare event — and reaping its large OT: Do you ever buy options or create reward — instead of taking in premium any spreads to protect positions? FOR ONLY 5 and exposing yourself to such an MA: No. We experimented with a event. What do you think about this? MA: The problem is you lose money while you wait. And that can be a very serious problem. You might have to credit spread program, but in my opinion, we spent so much money buying the further-out options, it was- n’t worthwhile. $ wait 10 years before you get an event like that. And you may have lost half, OT: So instead you might tighten the PER TRADE ** or more than half. How many puts can stops a little more? you afford to be long? MA: Exactly. That is our defense mechanism. Normally, we don’t hedge We’ve got the tools. OT: Can your strategy be profitable in with the futures, and we’re not buying all markets — up, down, and side- other options. I’m aware of all these ways? other strategies, but we don’t do that. I And when the need arises, MA: We’re going to struggle if the believe in the principle of Occam’s we’re there for you! market suddenly spikes up or down. Razor — when there’s more than one Unlike most active trader But we could make money in either solution to the problem, the simple brokers, we haven’t bear or bull markets. And it’s pretty one is usually the best. forgotten that even the obvious that we’re going to profit in a If an option’s getting in trouble, we savviest trader expects flat market. just buy it back. It’s called the turtle customer service that can be defense — you pull in your head and depended upon at OT: What percentage of your sold wait for the storm to blow over. critical moments. options expires worthless? MA: We don’t really let any options OT: Could you describe a previous Open an account today expire worthless. We buy them back trade? and see what everyone is around $0.40. At least 75 percent of our MA: We sold May 1,195 puts and 1,050 talking about! trades are successful. But our [individ- calls when the S&P 500 traded at Come visit us at: ual] losers may be as big — if not larg- 1,129.49 on April 14, 2004 (see Figure 3). er — than our gains. The calls lost most of their value as the S&P dropped nearly three percent over OT: Do you set stop-loss points? the next four weeks, and we bought *Barron’s 2005 survey of online brokers ranked thirty firms based on Trade Execution, Trade Technology, MA: Yes, we enter a good-till-can- them back at $0.40 each. Although the Usability, Range of Offerings, Research, Portfolio celled stop-loss order for every option puts got stopped out the next week, the Reports, Access/Help, and Costs. we’re short. overall position gained ground. **ECN fees apply to self-directed trades Option trading also available OT: How do you determine your stop- OT: How helpful is the Ansbacher loss? index (the ratio between prices of Options trading is risky and not suitable for all investors. Before investing in options, please read MA: It’s a certain ratio of the option’s near-month OTM calls and puts)? How the Options Disclosure Document carefully. This price. If we only have a few options on often do you track it? document is available at or by sending an e-mail to one side of the market, we [loosen] continued on p. 12 Member NASD / SIPC OPTIONS TRADER • January 2006 11
  7. 7. OPTIONS TRADER INTERVIEW continued FIGURE 3 — SELLING OPTIONS ON THE S&P 500 Ansbacher sold both calls and puts on the S&P 500 on April 14, 2004. He bought back the calls for a $2.55 profit on May 12; the puts got stopped out a but when you’re actually tracking week later. But the overall position was profitable. them, what’s extreme? With hind- sight, you can always pinpoint the high, but does that mean you can use it in real-time? OT: Why was 1997 such an extraor- dinary year for your fund? MA: After the big drop in October, the VIX went way up and we were able to take in a lot of money. I also started 1997 with a lot of option value left over from the year before. But we’re never going to see a year like that again because of our enhanced risk-management program. That’s the trade-off we made [in 2002]. We wanted lower volatility in our results, so we’re never going to have those outsized profits again. Source: OT: What type of changes did you MA: It’s not that formal anymore. I measure it whenever make in 2002, and why? I’m interested. MA: In the past, this was really a one-man firm, and our clients were almost entirely high net-worth individuals. OT: So it isn’t necessarily a trade signal? Many of them wanted us to make as much money as we MA: No. But it gives you an idea [of market sentiment]. It’s could, and if we had a big monthly loss, they weren’t too a way to come up with a number expressing the different upset as long as we made it up in a couple of months. We prices of puts vs. calls for equally out-of-the-money strike usually did. prices. So if the S&P 500 is 1,200, look at the 1,280 calls and In 2002, however, I decided to enter the institutional mar- the 1,120 puts that expire in about two months and divide ket, and they probably never want to see more than a six- the call price by the put price. In the S&P 500, the puts are percent loss in any given month. So I hired another princi- almost always worth more than the calls. They vary from 50 pal (Khan Noorpuri, the firm’s bond trader) and dramatically percent more to three times as much. improved our risk-management program. [In addition to placing stop-losses on all trades], we don’t sell nearly as OT: Has the Ansbacher Index’s historical extremes many options as we’re entitled to under the margin rules. matched prior highs or lows in the market? MA: It’s a very bearish sign when the calls are nearly as OT: You had a 5.51-percent loss in 2000 and gained just expensive as the puts (a value of 1). If you didn’t know, you’d 2.3 percent in 2002. How were those market conditions dif- think it’s a neutral market. However, it shows tremendous ferent from other profitable years? optimism in the market. Everybody’s long — a good time to MA: 2000 was a tough year for a lot of people. As I men- start selling calls. tioned, we have problems when the market makes big spikes up and down. In 2002 the bear market was ending. The mar- OT: Did the index signal the market peak in 2000? ket would shoot up before plunging again, and so forth. MA: Yes, and also in 1997. [But as a shorter-term signal] it But if the VIX falls too low, then we really can’t make doesn’t work any better than other sentiment indicators. much money. That’s probably why we weren’t doing as well this year. The implied volatility is so low now, we just OT: Does it work better than the put-call ratio? can’t take in very much money. Our actual returns through MA: How well does that work? You can say they’re helpful, the end of November were 9.4 percent. 12 January 2006 • OPTIONS TRADER