Hi Ryan,
If you bought the stock for 12 1/16, then sold the Oct. 12.50 Puts for 2 1/16 (bid) and the Oct. 12.50 calls for 2 1/4 (bid). Your NUT would be 7.75. You have downside protection to 7.75, upside to 16 13/16. If called out you make 62% in 3 months. If you think it's too risky, buy the Oct. 10 Put for 1 (ask), or the Oct. 7.50 put for .50 (ask) as downside protection. Purchasing the 10 strike would make this an guaranteed position, because you'd own the stock @ 8.75, and would be guaranteed that 1.25 profit, no matter how low the stock fell below 10. So, you can guarantee a 1.25 on an 8.75 investment in 3 months (max). So, worst case is a 14.3% profit during that time, best is 61% (or 43% with the protective put). Someone tell me if I'm missing something. Hmm...I've almost convinced myself to dip into margin to make this play...Tell me what you think of these 2 companies all...
Bridge Player has raised the right questions regarding this scenario. I've been looking at some of these combination plays myself, and it seems to me you have not correctly considered the potential consequences of writing the put. If you look at best case and worst case scenarios, the most return you can get is the premium plus the 7/16 gain on the underlying, which gives you a gain of 4_3/4 or 61.3%. However, the worst case is that if the stock falls to zero you lose your initial 7_3/4 plus an additional 12_1/2 you must pay somebody for worthless stock for a total loss of 20_1/4. Breakeven is actually at 10_1/8. For any closing price lower you wind up owning twice as much stock with an average nut at the breakeven point.
The protection you get from the strike 10 put reduces the greatest possible loss to 11_1/4, while reducing the maximum gain to 3_3/4, or 42.9%, and it raises breakeven to 10_5/8. For any closing price between 10 and 12_1/2, you wind up owning twice as much stock at this breakeven price.
While both of these provide reasonable protection, neither one guarantees a profit if the stock takes a dive. As always, buying the protective put reduces your worst case downside at the expense of limiting your greatest possible gain and raising your breakeven.
(Dan, did you get my private email I sent you?)
Yes, and sent a belated reply.. thanks.
Dan |
