Ever cross your mind for those playing short guts.

What happen if you have short guts on Bear Stearns?

We see Enron, Worldcom and now Bear Stearns, if you happen to construct a short guts on 1 of them can you still roll?

Hi Dave,

I wanted to do a short guts on Bear Stearns BSC when it dropped to $30+ because the IV was 300%. I held on because I suspect something more drastic will come.

And it gapped down to $4 the next day.

Like this How?

JK

hi dave,
i think that could be quite disastrous wouldnt it? you have any better idea of playing the short guts? do let us know, thanx in advance. :)

rgds
ky

Thanks everyone for posting!

Yes, BSC gap-down made short guts a bad technique yesterday. Traders who do not write options (options buyers) will testify options selling is a risky and unproductive technique.

Let's look at a day before it gapped down.

BSC was trading at $35. It was very tempting to open a short guts trade (as mentioned by JK). The 25 call was at $15, 40 put was also at $15. Total premium was $30. Time value=$30-($40-$25)=$15. Huge time value.

The underlying gapped down to $5. That was a loss of $20 (calculate from $25 to $5)

The net loss from this trade was $500 per set of short guts.

To repair, one can sell the Oct 08 strike price 5 call options, for a premium of $4. Time value=$3.

As you can see, by Oct or end of 2008, the trade will go break-even.

In fact, there is a better alternative than this. Just forget about this trade. KY, do you remember you calculate you could get $100-$200 time value from selling QQQQ short guts per month? Use this to compliment the losing trade from BSC. Who knows BSC will recover one day? The stock is already at $5-$7, it can not go to negative territory.

That is why we always tell participants with trading capital less than $5000 to stay put with exchange-traded-funds (ETF). They do not gap more than $30 in one day. (touch wood...)

For traders with bigger account ($25k and above), you will have 15-20 sets of short guts. Each set is targeted to give you $200-$300 time value, isn't it more than enough to break even in one month?

Anyway, this was the only one underlying that gapped down more than $25 in many months, in many years. None so far for financial industry. That was the first. We do not know whether there are anymore to come.

So, stay one short guts per underlying. The rest will take care of that one bad apple.

Etradehome.com
Any commentary or illustration generated in this forum is provided for educational purposes only. You must decide your own suitability to buy or sell options. This is neither a solicitation nor an offer to buy/sell stocks or options. Commission was not taken into calculation. Note: You have to know the risk of options writing before execution, especially naked call/put writing, bull/put spread, covered call writing, short straddle, short strangle, short guts, short/long iron butterfly, short/long wingspreads and short/long box.

hi sun,
thank you for your analysis of this trade... your suggestion seemed feasible. :) sell calls into the oct and at the same time using the premiums of the other underlying to make up for this loss, which can be covered easily then.

a closer look would indeed make this bear trade loss more manageable now. :)

ky

Thanks everyone for excellent questions and answers. Check out the scorer board!

hi Sun,

very good analysis. $500 is easily repairable. Only problem is if you have constructed a short guts before last friday, meaning you already start rolling and repairing when BSC have been dropping to $35 and 1 more drop to $5 is diaster. But if you have open a short guts on friday just before the drop likely no issue here easily recover by other trade. I have the same belief forget about this stock. Use other stock to recover back. It might take 2 - 3 months to recover but no point hanging on this stock.

For me I always prefer index futures options over stock options for the above reason. As for ETF options OTM premium is too little to be worth my effort.

But again if one can generate consistent income of 5-10% that is good strategy the key here is consistent

Hi Dave,

Yes, I agree if the position was constructed before it gapped down months ago, despite all the roll down and forward, the loss will be greater than $500. The repair takes longer, probably 6-8 months. Anyway, I am glad most options writing positions could be repaired, either by the same underlying, or through other underlying instruments.

Luckily I did not construct anything on BSC even thought he IV was high, very high. It scared me.

I will look into E-mini in the future. How about the margin requirement for E-mini? I heard it is higher than stocks.

Have a good weekend.

JK

Hi Dave and JK,

Yes, the repair will take longer if we have constructed the short guts earlier. Probably 6-8 months, like JK noticed.

As long as the position is repairable, it is a relief. Long call long put can not be repaired. Again, that is why good traders will limit to one short guts per underlying, more on the ETF, E-mini, holders etc.

Have a nice and slow week ahead.

Etradehome.com
Any commentary or illustration generated in this forum is provided for educational purposes only. You must decide your own suitability to buy or sell options. This is neither a solicitation nor an offer to buy/sell stocks or options. Commission was not taken into calculation. Note: You have to know the risk of options writing before execution, especially naked call/put writing, bull/put spread, covered call writing, short straddle, short strangle, short guts, short/long iron butterfly, short/long wingspreads and short/long box.

On a second thought, it was just one of the many short guts that went wrong, if I were to construct this trade. The rest, so far, being protected by rolling down. The time decay will take care of this rotten apple, oh, rotten bear. Yak!

Thanks for the discussion on this. It makes me feel more confident in options writing.

JK