EDUCATION: BACK MONTH DURATION SELECTION FOR SYNTHETICS

4 ก.ค. 2020I have on occasion highlighted the benefits of using various options strategies instead of getting into stock, not the least amongst them being buying power effect. Pictured here is a 98.35 delta long call in SPY in the December 16th '22 (896 Days Until Expiration) cycle costing 183.35 ($18,335) to put on versus 312.23 spot (i.e., it would cost $31,233 to get into a full, uncovered one lot of SPY here). Although even this highly delta'd long call is "dynamic" (i.e., its delta will change in response to movement in the underlying, decreasing as price moves into the strike and increasing as it moves away), it is -- at least at the outset -- near being equivalent to being in long SPY stock at the strike price (130) plus its value (183.35) or 313.35.*

Such deeply monied longs generally stand in for stock, which are then covered with a short call to emulate a covered call without paying covered call prices. This is particularly important in a cash secured setting where buying power is limited or in small accounts where getting into a full one lot of certain underlyings is prohibitive. Naturally, even getting into this particular long call will be beyond the reach of some smaller accounts, but I'm using SPY here as an exemplar; the same delta and duration considerations apply with any underlying.

Generally speaking, my rule as to duration with the back month long has been to "go as long-dated as you can afford to go," since having a longer back month duration allows for a maximal number of opportunities to reduce cost basis via short call. However, if your go-to strike to buy as your stock substitute is, for example, something around the 100 delta strike,** then going longer-dated usually means that you'll have to go deeper and deeper in the money to buy that strike, and that usually gets more and more expensive as you go out in time. But does it?

Here's a look at SPY long calls around the 100 delta and their cost over time:

October 16th 155 (105 days) 158.15
January 15th 130 (196 days) 183.20
March 19th 130 (258 days) 183.50
June 18th 130 (350 days) 183.35
September 17th 130 (441 days) 183.35
December 17th 130 (532 days) 183.30
March 18th '22 130 (623 days) 183.30
June 17th '22 130 (714 days) 183.30
December 16th '22 130 (896 days) 183.35

Interesting, huh? You basically don't pay more by going longer-dated between January of '21 and December of '22. Naturally, this might not always be the case; currently, expiry implied volatility slopes away somewhat from shorter duration implied in SPY, with all of '22 being between 22.6 and 22.9%, and we've had substantial periods of time where it is the exact opposite: implied slopes upward from short to longer duration. Put another way, you'll probably have to look at whether going longer duration makes sense each time you get ready to set one of these up.

Just for kicks, I also looked at QQQ:

October 16th 130: 122.95
January 15th 112: 141.00
March 19th 105: 148.05
June 18th 92 (lowest strike available): 160.05
September 17th 92 (lowest strike available): 161.00
June 17th '22 92 (lowest strike available): 161.00
December 16th '22 92 (lowest strike available): 161.50

Not much difference between going June of '21 versus December of '22.

And EFA (albeit with fewer available expiries to look at):

December 18th 25 (lowest strike): 37.02
March 19th 25 (lowest strike): 37.02
June 18th 25 (lowest strike): 37.00
January '22 25 (lowest strike): 36.88

No significant difference between December of '21 and January of '22.

And TLT:

October 16th 95: 68.55
December 18th 95: 68.55
January 15th 95: 68.55
January 21st '22 95: 68.55
December 16th '22 95: 68.60

No significant difference between October of this year and December of '22.

In a nutshell: where there isn't a significant difference in price between shorter and longer duration of the same delta, go with the longer duration. It'll afford you with more time to reduce cost basis and/or generate cash flow via short call premium.


* -- That particular strike is bid 181.90/mid 188.35/ask 184.75, but would to get filled somewhere closer to spot (312.33) minus the strike price (130) or 182.33. In all likelihood, you're going to pay some small amount of extrinsic, but would start price discovery there, since a strike near the 100 delta should be almost all intrinsic value.
** -- My general go-to in the past has been to buy the back month 90, sell the front month 30 to obtain a net delta metric of +60. Buying a slightly lower delta'd long will obviously cost less (e.g., the 90-delta December 16th '22 is at the 205 strike and would cost 114.25 to put on versus the near 100 delta 130's cost of 183.35), but will also have more extrinsic in it.