Twenty minutes later I closed out SPY at 108.11, S104 puts at .08, and bought back my calls at 1.62 for a net credit of  106.57,  a net profit of 0.41 per share.     With almost half the available profit available that quickly I couldn’t justify holding onto the position.

SPY 31-Aug and 1st of Sept 2010

Livevol shows the 27-Aug 106 IV’s at 28 and the 18-Sept monthly IV for the 106 calls at 24.  Right now, Livevol’s IV numbers are the only ones I believe for the CBOE Weeklys options.

Usually getting the prospectus for a new ETF or ETN takes a Google search and a couple minutes of browsing.  The prospectus for Barclays’ new XXV inverse volatility ETN proved to be a much more elusive search—it didn’t show up in the top 20 hits.   Reading through the fine print of the XXV Fact Sheet provided this pointer for web access:

Before you invest, you should read the prospectus, prospectus supplement, pricing supplement and other documents Barclays Bank PLC has filed with the SEC for more complete information about Barclays Bank PLC and this offering. You may get these documents for free by visiting EDGAR on the SEC website at www.sec.gov.

Even finding the prospectus on EDGAR proved to be frustrating.  My search in Edgar’s company search for  ”Barclays Bank PLC”  resulted in a  lot of hits, but 20 minutes of clicking did not yield anything XXV related.    I finally did an  EDGAR text advanced search with XXV as the text and Barclays Bank PLC as the company to find the XXV prospectus and a few other related documents.

I have only started to dig through this 66 page document, but so far the most interesting aspect of XXV is its “Automatic Termination Event”—which liquidates your position if the intraday indicative note drops to $10 or less.   I don’t know of any other ETN or ETF that includes a built in stop loss order like this.   XXV is effectively a short of VXX, and as investment writers are fond of reminding us, a short position can theoretically result in “infinite” losses.  The people at Barclays have decided to block the infinite losses scenario  by limiting an investor’s potential maximum loss to be whatever they invested minus around $10 per share.

Somewhat sobering, the prospectus finishes the section on Automatic Termination Event with:  ”If the historical frequency of precipitous increases in market volatility persists, it is highly likely that an automatic termination event will occur”.

This is probably not an investment that you want to buy and hold…

Recently I had deep in the money puts and OTM covered calls on SPY in my IRA account.   As expiration approached I begin to wonder what would happen if I didn’t sell my puts.  If the options were cash settled, like VIX index options, then there would be no question,  the value of the puts at expiration would just be credited to my account.   But since SPY options are physically settled you would normally expect an expiring  ITM put to trigger a short sale of the underlying at the equivalent of the strike price.   Except in an IRA account you can’t sell short.

I spoke with someone at the Fidelity active trader helpdesk, and they said that if you didn’t have the appropriate amount of underlying in your account at assignment, then they would indeed create a short position in your IRA account.   The next step (and I got the feeling there was a pretty short fuse on this) would be to contact you and ask/tell you to close out the short position.   If they aren’t able to contact you , then they would cover the short position by buying the underlying in your account.   Between the time of the assignment and the cover you would be exposed to the market moves of the underlying.    Through this scenario I don’t see how a “free riding” violation could occur, but with long ITM calls I think there is some potential to trigger a violation.

In my situation, my long position in the underlying would cancel out the short sale, so I could let the puts expire, gather the last of the premium on the puts  (my short calls were so far out of the money there was no chance they would be exercised), and comfortably reside in cash over the weekend.

Otherwise, if you aren’t going to be long the underlying at assignment, it looks like a good idea to sell those ITM puts before they expire.

SPY obliged, and when it reached the 110 to 110.1 range I re-established my short call position with 110 strike calls at 0.49.   This move capped my upside, but lowered my break even on that lot of stock from 110.22 down to 109.81.   I wasn’t optimistic that SPY would recover all the way back to 111 today, and I prefer to have my stock called away so that I don’t have any exposure to weekend events.

SPY closed at 110.27, so all my stock will be called away.  Most of my 0.375 / share profit came from the Thursday position established at 110.12, but I was pretty pleased to still make a profit on my Wednesday 111.07 SPY purchase—compliments of the small insurance policy provided by the call premiums.

I like the way that short term options provide a little cushion against contrary moves, plus generating respectable returns if the underlying goes up or sideways.  The option time premium eroding away gives me an incentive to stick with a position, rather than being tempted to take quick, small profits, or bail out when the market turns ugly.

I really don’t like the asymmetrical risk behavior of covered calls—it severely limits your upside, while providing only a small amount of down side protection.   The good news is that your overall time exposure on the weekly calls is short and if the market really turns ugly your (now) OTM calls will be pretty cheap, even with elevated IV,  if you decide to completely close out your position.

I called the Schwab options desk recently (877-673-7959) and they said that they do plan to offer weekly options, but not for a while.   The person I talked to said it would probably be a month or two.

Taken from http://www.option911.com/blog/option-education/how-option-time-premium-decays-over-the-weekend/, click to enlarge

All of this is of course modulated by any changes in the volatility of the underlying, and the market in general.

Some traders avoid options close to expiration because of these factors–and others flock to them.    As a covered call writer I am really attracted to the accelerated time decay of short term options.   I’m not taking any more risk than normal holding the underlying, and I am getting an accelerated decay in the price of the options I am short on.    I will often wait until there is only two or three weeks are remaining on the options to create the position.

Now it can be expiration week, every week for the following Stocks / ETFs (taken from this CBOE posting):

Weeklys on Exchange Traded Funds and equities. As of July 5, 2010, these included the following::

• SPY – Standard & Poor’s Depositary Receipts
• QQQQ – Nasdaq-100 Index Tracking Stock
• IWM – iShares Russell 2000 Index Fund
• GLD – Options on SPDR® Gold Shares
• XLF – Financial Select Sector SPDR
• EEM – iShares MSCI Emerging Markets Index
• C – Citigroup Inc
• BAC – Bank of America Corp
• AAPL – Apple Inc
• BP – BP PLC
• F – Ford
• GOOG – Google Inc.

Fidelity supports trading on these new weekly options, but Schwab does not appear to.   Beware of the listed greeks on these options, the software may not be using the correct time until expiration.

The volume, at least on the SPY weeklies has been substantial (20K today on the 105′s expiring 9-July), so I think the options providers have a winner.

For more information see this options clearing house post.