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Strategies & Market Trends : Options 201: Beyond Obi-Wan-Kenobe
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To: Dan Duchardt who wrote (6)8/10/2001 9:49:49 PM
From: Dan Duchardt  Read Replies (1) of 1064
 
Some additional thoughts on the covered strangle:

In may previous message I stated that for a covered strangle the initial rate of loss of value the position is about the same as for uncovered stock ownership, and accelerates to two times that rate as the price falls. Suggesting that a drop in price of $7 for stock might equate to a $12 drop in the value of the position was a very rough estimate. I looked at QCOM end of day prices today with the strategy analyzer and found that a short straddle with JAN75 calls and JAN65 puts would bring in a premium of $16.30 per underlying share at $63.77. The projected reduction in value of the position at various prices below are as follows:

60 -$3.49
55 -$8.76
50 -$14.81
45 -$21.68
40 -$29.35
35 -$37.77
30 -$46.83

The accelerated loss is not quite so bad as my estimate may have implied for this particular stock, but the ultimate rate clearly does move toward twice the rate of stock loss. Going up, the price increases are:

65 $1.05
70 $4.94
75 $8.25
80 $11.06
85 $13.42

On 10/1/01 at 60 the position would be at breakeven, $350 up from the initial negative value, while at 80 it would be $15.10, up $4. Those increases are the result of time decay of the option premiums over the next 8+ weeks

If the short put is backed by cash, the declines in value of the cash backed covered strangle is never greater than outright stock ownership had the cash been spent to double the position size. However, the short put typically does not need to be covered by cash, and could be margined in the range of 10 to 20% of the stock price. If on top of that the underlying long is purchased on margin at 50%, the rate of loss of position value approaches 3+ times the rate of decline of stock price. So there is a big difference in the risk if you are talking about a cash backed covered strangle as compared to a fully margined position.

Dan
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