Cut-to-the-Chase Formula for Long Call/Put Analysis.
(Read this so in the future you’ll understand how we get our Limit Entry premium for going Long either with a Call or Put and/or reverse your position by Selling – creating appropriate option spreads. The original contents of this post was posted on a prominent trading brokerage platform that immediately censored – blocked and deleted my post – citing that it broke their forum posting rules.)
Note: Credit goes to Tom Sosnoff and his brilliant staff at Tastytrade/Dough for the initial presentation of this options trading methodology. I have tweaked it a bit only as a means to augment the fundamental inputs.
The Covered Call Strategy
We present a qualified simple formula to reduce your limit price entry cost. We’ve posted our excel spreadsheet data to show how it works. The key to our work is “transparency” with the exchanges Bid/Ask pricing – e.g. BATS has laggard price formations versus, say NASDAQ.
For tomorrow, we’ve set up a SEPT (21) Limit Entry Long Call for FITB. This is based on our preliminary scan – from our proprietary NQ2 model.
SEPT OPTION LONG CALL: FITB (Fifth Third Bancorp)
From Left to Right the above graphic is explained:
“OPT” designates the Call/Put rows; Trade Signal which is verified to be a Long Call, since the Put signal is “Sell” (based on a volatility calculation); Strike Price is listed for the Call Premium that is next under “Current”. (FIFTB close price is $20.25, that gives us a $0.25 edge since we’re going to be executing a debit trade.)
“Limit Entry” is a proprietary calculation that we use to reduce our cost basis – anticipating what is most likely the pull back premium price for tomorrow’s opening – typically during the first hour.
This is so we capture (most times) a profitable position and/or set up a “buffer” or “risk aversion” entry. The “TGT P” is the calculated Target Price based on the underlying liquidity. This will change during the day, but it gives us something to shot for and moreover to compare to the chart for technical moving averages overlay price levels. “Cost” is our initial capitalization and “Close” is what the amount gained. Our potential profit is $75.75, having taken out our commission fees. We calculated our risk aversion cost (not shown here) to be $17.33. The Call Ask/Bid spread is 0.4 (four cents); whereas the Put spread is currently .11 (11 cents).
Covered Call Formula & Limit Entry Price Calculation to Reduce Cost Basis
What we want to know over all with the underlying asset is its “Liquidity”. Thus, we calculate this by simply dividing the assets volume to shares. If “Liquidity” is below .50% than it is considered “LOW” and there will be little price action until the Liquidity goes up. (1% or higher is preferred for determining the Premium’s price movement and Ask to Bid spread.)
The “TREND” is determined by the current price compared to the “OPEN” price when the market opened for the day. The “IV SIGNAL” is a calibrated formula using Implied and Probability statistical equations to determine which side of the assets option chain to lean into. We’re searching for “robust” Long Calls. Robust is defined as being above average in performance that moves individually from the overall market performance.
DERIVATIVES – COVERED CALL
*We are writing this “after hours” when the market is closed. Thus, the “Liquidity” is skewed because the necessary input parameters are not operating within the intraday activity – correlated to the market indexes performance.
Taking the “underlying asset” into account, below is our data inputs and parameters to watch for validation, continuation of our chosen directional move and/or a pending reversal.
The “Price H/L” price is above is a positive sign that the price will continue upwards. The “Average” is the Mean, and the “Offset” is a calibration from our formula set; similar to One Standard Deviation of the underlying price. Currently, this is above the “Last” price that validates the probability of a profitable Long Call.
This price will drop below the “Last” during intraday trading. The key is to the number of occurrences that occur; that signal a continuation of the Trend, or a soon to come reversal. (If we notice a “Flash” with this price – that is a “ping” that causes an anomaly of the price range, than it’s a signal that High Frequency Traders are testing the market to “bait” Institutional investors into unloading large inventory orders.
That brings us to the “Decay”. This is rather ingenious: a hybrid calibration of Time Decay and Duration formulas. Right now, with the market closed it is a high percentage, because it is tied to the Bid and Ask spread of the underlying asset. What we ideally are looking for is a value around .25% to .45%. Moreover, what is not shown here is our NQ2 Greeks – the Alpha, Beta, Sigma and Omega value parameters that validated FITB to invest in with a Long Call option.
|EQUITY – FITB
TECHNICAL CHART ANALYSIS
Above is the FITB Day Chart. The breakdown is this:
EMA Overlays Price Levels
The Line Trend has bounced off of the 377 EMA (Green Line) going upwards toward the 34 EMA (Red Line) having crossed over the 13 EMA (White Line). Above this is the 144 EMA (Yellow Line), tied in the 89 EMA (Blue Line). There are not Binary Events posted (Earnings or Dividends).
Price is Everything
The 377 EMA has set the Support Price Level at 19.51; 34 EMA Price is 20.37 – about 0.10 above the current “close” price of the day 20.25. This gives us some breadth for more upward movement. The 34 EMA (Red Line) can become the Resistance Price, which we will watch for during tomorrow’s session. Above this is the 144 EMA and 89 EMA that set the farthest out Resistance price at 20.77. The 13 EMA (White Line) is at 20.01.
Taking a look at our “Equity” block – the Average Price is 20.13 that falls within our “Price H/L of 20.51 and 19.99. Our “Offset” is 20.30, close to the 34 EMA price at 20.37, so we still have a playing field for a scalp play, if necessary.
The DMI oscillator shows the beginning of a Golden Cross – Bullish Signal.
Price to Premium
The current premium for a Long (Ask) Call at the Strike Price of .49 with a 0.4 spread. (Incidentally, this is a good sign when the market is closed, showing that the Bid/Ask spread remained tight, reflecting the fact that there is still a truckload of inventory waiting to be exercised on the trading desk.)
Not shown on the chart (it wouldn’t show up) is the Trend move from the point the Line Trend hit the 377 EMA (Green Line); and in “fractal”** increments, moved +4.05% or +$0.79 (11 Bars) over the past 14 days. (Todays move was +0.76% or +0.15.)
If FITB pulls back in price tomorrow – most likely it will be to 20.01(13 EMA) or 19.99 as our “Equity” block shows. That is roughly a .25 cent pull back, or .017 in premium terms, without calculating Delta and Theta. Thus, we came up with .42 as our Limit Entry order to reduce our cost basis, and brings us into a profitable position… because, the DMI is signaling a Golden Cross. (This is a contrarian method to the traditional arithmetic of finding the mean price between the Bid and Ask to be the Limit Entry Price.)
Lastly, that “Green Oval” on the chart is our Long Call Limit Entry Order position, right between the 34 EMA and 13 EMA.
With the 144 EMA gapping above the 377 EMA, there is a consolidation of price forming. With the sufficient drop back on July 16 – we’re over a 30 day window – coming into the final 15 days of our 45 day time horizon. So, we’re coming in on the tail end of the price volatility, before a new directional pattern forms.
** In consideration of Nodes and Edges physics, we are working on a new math formula that is based on quasicrystal formularies – addressing Hilbert’s 13th Problem. This is mainly to prepare for the Quantum Computers programming that takes the binary code and translates it into “Qudits”.
Below is our excel spreadsheet formula solution set that automatically calculates the Covered Call Return percentage. “C-RTN” is 0.67 which is the value signal that validates a lean into the Option Call. “Inverse” 0.33 is the opposite value. If we have a near equal C-RTN to Inverse then we are cautious about a mean reversion and or the underlying is starting a price fade phase. If the Inverse were 0.67 and C- RTN was 0.67 then we would consider purchasing a Long Put at the OTM Strike Price premium. (Still, one must consider the Bid/Ask spread, looking for a tight, consistent spread, which is another validation that Open Interest is keeping the volume momentum above average.)
For C-RTN price entry, we take the At-the-Money Strike Price for our chosen option month (10 to 45 days out).
The “Context” is Out-of-the-Money (OTM) and “In-the-Money” (ITM). We want the ITM value that is larger than the OTM comparatively 0.59 to – 0.73. The Intrinsic Value is calculated based on the “Monetized” formula, and below this “MON VALUE” is the high and low price range during intraday trading.
Covered Call Excel Formula
A1-5 are Labeled.
A1 – TICKER;
A3 – MONETIZED;
A4 – COVERED RETURN;
A5 – INVERSE
B1-5 are the Inputs/Equations.
B1 TICKER Symbol
B2 – Type in the number 5 – This is the remaining months in the year called ‘cycles’
B3 – Monetized Formula =SUM(Bid-Ask)/Cycles+Ask
[When the asset is over $100 you’ll need to write the formula as: =SUM(BID-ASK)/Cycles+ASK*0.1]
B4 – Covered Return Formula =SUM(Monetized*Cycles)*0.1
B5 – Inverse =SUM(1-‘Covered Return’ outcome)
For Example here is a NFLX set up we did earlier this week.
NFLX $468.58 (We’ll take the SEPT (31) Option Chain @ $470 Strike since NFLX shows a robust trend upwards.
B1 – 5
B2 =SUM(12.95-13.15)/5+13.15 Answer: 1.40
B3 =SUM(0.37*5)*0.1 Answer: .70
B4 =SUM(1- .70) Answer: .30
You’re Take Away is that NFLX has a higher probability of profit if you Buy a Long Call entering ATM. We used the 470 Strike Price.
Next: Reducing your Cost Basis with a solid Limit Entry Price order.
Generally speaking, once you purchase a Premium, you’ll lose 1/3rd of the value. Within 15 days the premium decay is another 3rd. Empirical data shows that 45 days seems to be the bell curve peak for a probability of profit outcome, or when you would considering taking your profits off the table, if you haven’t already.
A simple way with a robust outcome is to divide the at the strike Ask premium price by 16.
For confirmation we calculate the Limit Price difference from the Premium to the underlying price on the chart at 15mins – to determine if the pull back is feasible to take the limit price. The square root of 252 trading days is 16, thus the use of 16ths that is correlative to any other TC method’s outcome.
The NFLX Limit Order Entry was 11.07 to BUY a SEPT (31) LONG CALL @ 470; x2 Contracts. Our profit $664.00.
Note: We use a hybrid Time Decay Formula calibrated to ‘Duration’ that provides an explicate outcome. At the time of our trade it was .24%.
(Disclaimer: We are not recommending trades and will not be held liable as such. This post is strictly for educational purposes and posting the development of our NQ2 Model. The reader agrees to taking responsibility for their own trading regardless. The formula(s) presented are “hybrids” so one must take extreme caution in understanding the “bootstrapping” aspect of this post. Constructive questions, feedback , insights are welcomed. We encourage you to use the Santa Fe Institute – Complex Systems curriculum for more academic information and insight.)