WRITING TRADED OPTIONS for income

Having now spent many more hours studying this strategy, I agree that individual stock IV shouldn’t feature in basket replication.

The general idea is that you want exposure to each stock in your basket in the same ratio as those stocks are weighted in the index. For example, BP and Shell are weighted pretty much equally in the index, so you should have the same exposure to BP and Shell in your basket. Similarly, where RBS is twice the size of RIO in the index, you should have twice the exposure to RBS as you do to RIO.

”harder to get the right strike, pity LIFFE has such wide strikes”

Yes and no. Ideally you’d want to trade precisely ATM where the delta is 0.50. However, you can almost always find a strike giving a delta between 0.25 to 0.75, and you can make an adjustment to the lot size bought/sold accordingly. The only slight drawback here is that whereas all ATM options have a delta of 0.50 regardless of IV, as you move away from the money, IV will change the Delta value, somewhat.

Don’t forget to add the broker surcharge to your Margin requirement – 25% at ODL. More at Sucden’s I believe.