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SimpleOptions 2013.07.18
1. Create a valuation of the underlying.
2. If the valuation is significantly lower than the current
price, consider buying put options.
3. Round the underlying's current price up to the nearest
multiple of 5 and call it H; round your valuation down to the
nearest multiple of 5 and call it L.
4. Find a few expiration dates for which options are being
heavily traded, e.g. 6, 12, and 18 months into the future.
Avoid nonstandard options.
5. For each of these dates, pull Asks for every strike price
that's a multiple of 5 between L+10 and H+10 (inclusive).
6. Compute the payoff of each of these contracts for a constant
amount invested (assume fractional contracts) when exercised at
underlying price X, where X is a whole number between L and H.
7. For each contract, find the mean payoff and subtract the
amount invested.
8. Estimate the likelihood of your valuation obtaining prior to
the expiry of the longest contract, e.g. 75%.
9. Find a constant R such that 1 - exp(-D/R) is roughly equal to
the estimate in step 8, where D is days until expiry.
10. Use R to scale the expected payoffs of the other contracts
according to their durations.
11. Purchase the contract with the highest expected payoff, if
it's positive.
12. Exit on the first of these conditions: unrealized profit
equals expected payoff, underlying trades at valuation price,
contract expires.
Summary of variables:
L - lower bound of expected prices
H - upper bound of expected prices
X - whole dollar amount between L & H
R - rate constant
D - duration of contract (in days)