The ins and outs of debits & credits

Notes on debit & credit orders.

Tutorial: Debit and credit orders are combination orders used to simultaneously buy or sell different security types (e.g stocks and options), where you don't care about the prices you pay/receive on the individual securities, just so long as the total is equal or better for you than the amount you specify.

These are useful for several reasons:

1. You remove the risk that the stock will move against you between the time you put the 1st position in place until you can get the second in place
   
   
2. Often you drop into some internal sanctum of brokers where the pricing rules that mere mortals have to adhere to are missing. For mortals you can't go below 1 cent increments on your stock price, or 0.05 for options below $3, and 0.10 on option prices above $3. With a debit or credit order you will sometimes see your stock price go to 3 decimals (e.g. 127.238) and the options down to the penny
   
   
3. With these orders you are in a much better position to try and beat the "spread" between the bid (what the market maker will buy your stuff for) and the ask, which is what the market maker will sell the security to you for. When the stock is jumping around on a busy day it is scary to make an offer between the bid/ask because you might miss out if the security moves the wrong way. Even tougher, if the bid / ask on an option is only a tenth for a option above $3 (e.g. 4.1 bid / 4.2 ask), you can't even submit an order that splits the spread.
   
   To keep debit and credit straight, my mnemonic is : debit -- me going into debt, credit -- me getting the credit. I use debit orders for doing a buy/write (buying stock and selling covered calls) or credit orders for closing them out. Don't try to use "market" combination orders, these aren't handled automatically in some cases and can take a significantly longer period of time for one half to execute -- which defeats the whole purpose of the debit/credit order.

• I had several recent debit orders execute quickly -- which implies I was leaving money on the table (or in one case I was just being stupid). The coarseness of the option pricing vs the underlying typically adds 0.1 of slop in the pricing (on options above $3 anyway)--so that needs to be factored into your bid plus at least splitting the bid-asked spread.
  
  It isn't hard to change the order, so I'm thinking I should start at 2/3rds of the spread + the slop factor should be the starting point. For example, for a buy/write: if the underlying is at $54.35, the $47.5 calls at 6.90 bid, 7.10 asked (0.05 of premium on the bid price) . Then, the slop is .05 at this point (the option probably won't go to 7.o bid, 7.2 unless the stock reaches $54.40 ). The spread is 0.2, so 2/3rds of that is 0.13. So a reasonable starting debit offer for a buy/write would be: 47.5-(0.05 premium already in bid price+ 0.05 slop + 0.13 bid/ask split) = $47.27. This is an offer designed not to leave much money on the table, but not wasting your time with a no-go offer.
  
  
• In some cases debit /credit orders don't work well at all. If you order is split up and each part goes to a different exchange, then the tight time coordination and ability to beat the spread is lost. If you see stock / option pricing go by that should have triggered your order, but didn't, this is probably what happened. You should cancel and drop back to manual control at that point.

A little further down the path on dividend trading--late June

Regarding option assignment, I obtained a fair amount of data this week.

• Out of the possible 17 options contracts I was short on that could have been exercised for dividend capture only one, a BestBuy (BBY) option was assigned. This data suggests that if you can lock-in a little profit in the few days before a stock goes ex-dividend on a buy/write that the odds of being assigned are significantly lowered--even if the option is significantly in the money ($10 in the case of BBY)
• One other data point -- the fact that only one of my 7 BBY options got assigned gives me hope that playing the odds on the Strike prices that only get partially cleaned out is a viable strategy.
• In the school of hard-knocks category, I closed out my GSF position, but adjusted the credit offer the wrong way--I was't thinking this was the point at which I wanted to increase my offer as much as possible--I guess I have been doing too much buying and not enough selling.
• That's the bad news on GSF , the good news is that either with the assigned call (profit of .21 per share, or with the dividend plus option premium (profit of 0.425 per share) this was a strategy yielding 12%+ on an annualized basis.
• Final analysis on IVV (SPY wannabe) options -- none of the options were exercised at ex-dividend time, plus finding out the ex-dividend date is a bear. Skip this next time around.
• Final analysis on FBR. 6.8% annualized yield ex-dividend 28-June. I tried to get into $7.5 options buy/write without success (not even a 7.5 debit worked). $10 options on the 27th might have been a fair play. The stock was at 11.5 and about 50% of the $10 options did not get exercised. The stock was very volatile however. All of the $7.5 options were exercised--so the $7.5 buy/write was a loser strategy from the get-go with no lock-in profit available.

Observations on Dividend trading -- buy/writes

I will know more in the next day or two whether this stuff works the way I expect (options assigned), but I have already learned quite a bit with my recent intensive trading.

A quick tutorial. I am trying to make a small profit by buying a stock and simultaneously selling in-the-money options against the stock. I do this at a price point that locks-in a profit --where the price I pay (called the debit) is less than the strike price of the option. For example, if the stock is at $38 and I write $30 calls I will pay less than $30 for the combination (perhaps $29.80). My lock-in profit is this case is 0.20 per share. You need a fair amount of captial to make this worthwhile... I try to sell options that are well in the money (high intrinsic worth) because this protects my investment (Delta approx. -1) and increases the odds that the option will be assigned when the stock goes ex-dividend. If the option is assigned my position is automatically closed out and I immediate get lock-in profit (minus commisions of course). If the option is not assigned, I get the dividend from the stock, but the option price jumps up in the short term to negate that benefit. You have to wait (and tie up your money) until the option expires to get your full profit out in that case.

Some notes:

1. It's you against the computers. The market makers seem to make a decision whether they are going to allow any profit lock-in (buy/write with debit less that option strike price) on a stock by stock basis. On very high dividend stocks this is a given. When you get into the stocks yielding around 2% per year it looks less consistent.
2. If the bid value is near or above the breakeven value you are good to go. You can hope to split the spread or better. The longest I have seen a successful trade take is about an hour. Most of the time it goes pretty quick--making you feel like you have left money on the table.
3. So far I have seen the buy/write stuff work well when the market makers are willing to play. Otherwise you better be willing to take a loss up front and hope your options don't get assigned. I'll be looking closely that that assignment data in the next couple of days.
4. The big open issue right now is whether the options where the market makers are playing are going to be assigned. If not I will see the option volatility jump up and it could take until the options expire to get out with my profit (but it will be the buy/write profit plus the dividend)

Late June Dividend events & notes

Stock Ex-Div_Date Div Recent_Price Div/Recent_Price%
FBR __ 28-June ___ .2 __ 10.11 ___ 1.97%
SPY __ 16-June ___ .555 _ 124.65 __ 0.45%
IVV __ 23-June _ .528 __ 125 ____ 0.45%
BBY __ 29-June ___ .08 ___ 52.5 __ 0.15%
DE ___ 28-Jun ___ .39 ___ 80 ____ .48%
GSF __ 28-June __ .225 ___ 53 ____ .42%
CCU __ 28-June __ .187 ___ 30 ____ .62%
DOW__ 28-June __ .375 ___ 38 ____ .98%

Notes

• Tried without success to get any bites on buy/writes on DOW with debit amounts giving me any profit at all. My CCU order barfed on Schwab when I tried to do the buy/write at $25
• GSF on the other hand happily gave me a profit of 0.21 on 47.5 calls, I had tried 0.25 for a while with no takers, but 0.21 went immediately--left a few pennies at the table I guess. Ex-Div is tomorrow, so I expect/hope my position to be short-lived.
• I tried a zero profit offer with DOW -- ( $35 call with a debit of $35, but no takers). I ran a "science experiment" with DOW to see if the buy/write was not working well. I bought DOW at 38.01 and then tried to split the 3.0 / 3.2 spread on the $35 call with a 3.1 offer. Even though DOW got up to 38.04 there were no takers. I chickened out at that point and took my $28 in profits....
• On FBR: I tried a Buy/Write for $7.5 July Calls at 7.45 debit -- no takers
• On FBR: Since the options will almost certainly be assigned I wanted a little money up front
• On BBY: I did a Buy/Write for $42.5 July Calls at 42.35 debit -- it took an hour to fill!
• On BBY: It will interesting to see if the BBY Calls get assigned -- 3 weeks left before expiration
• Found an interesting web site www.amextrader.com -- gives ex-dividend dates a few days in advance