How to make a 350% annualized rate of return trading options, using the power4XL Black-Scholes Options Toolkit
No, I'm not that mythical character (whose ad probably appears adjacent to this paragraph) who claims to make a 1,000% return year after year by trading options. I think the only real way to achieve that kind of money in the options market is by selling your "secrets" rather than by actually trading!
However, occasionally I come across an interesting stock tip or market dynamic that pays off. I use the macros for black-scholes options analysis to evaluate the trade before I make it. Doing so sometimes yields perspectives and trading strategies I would not have identified had I simply traded on my gut instincts.
In this particular trade, I got a tip from a broker to short the stock of Zymogenetics, Inc. (ticker: ZGEN). Instead of shorting the stock, I decided to look at buying put options (the right to sell the stock at a future point in time at a predetermined price). So I pulled up the options grid on Yahoo! finance, and thought the options looked pricey. That's where the Excel analysis came in. Using the avol() and ivol() functions, I found that while the historical volatility was in the 40% range, the implied volatility of soon-expiring options was in the 80% - 90% range - a potential "implied volatility arbitrage". Thus it appeared that the options were overpriced, so I would be better off selling than buying. I wound up selling out-of-the-money call options, and placing a conditional "buy" order for the stock if it reached my break-even price on the trade. Ten days later when the options expired, the stock was trading at 10% below the price it had been on the day I bought the options. The money I would have needed in order to fund the conditional "buy" order sat in a money fund earning 4% (annualized), but the profits from selling the calls amounted to a 350% annualized return on the amount I had set aside in reserves.