jaytee,
Is it a sucker bet to ever use these low open interest calls (leaps) as proxies to stock for cc?
I don't think so. In fact, I think it is a very attractive strategy for anyone who believes the market is going to recover in the next many months to 2 years, and can give the position that kind of time to develop. Limit your downside, and be in position to enjoy most or all of the upside potential of stock if you have a little luck and manage the position well.
Something I found to be very interesting is that for your PWAV case the theoretical value of the position at September expiration is rather insensitive to the FEB ITM strike you choose. You could go as high as FEB15, and still expect to be ahead if called out. The theoretical gain at September expiration at 20 for a FEB15 purchased for 6.40, with SEP20 sold for 1.45 is $2.36, on an investment of $4.95, or 48%. Not only that, you will notice that the spread is not so outrageous for the higher strikes; it's still bad, but not as bad as the lower strikes. The disadvantage is that if you are called out because PWAV goes beyond 20, the theoretical gain curve sinks for the FEB15 while the FEB5 remains nearly constant. It cannot go lower than the boundary value of [SEP strike + premium (or $21.45) - FEB strike - premium] which is $2.65 for the FEB5, and $.05 for the FEB15. At 25, the position with FEB15 is still gains, theoretically, $1.56, or 31%.
If you are thinking near term gain, the maximum possible gain on the FEB15 is a lot better % than the lower strikes, but you risk erosion of that advantage if the price goes above 20. But, if you really are looking longer term, which would you rather own in February if PWAV stays above 15, a FEB5 or a FEB15? Obviously, the FEB5 will be worth an extra $10, but you will have paid (and risked) an extra $7.40 to get the FEB5. The "extra" return (10-7.40=2.60) on the "extra" investment (7.40) is 35% for 6 months. That is not bad, but the risk of losing that extra 7.40 does not paint the greatest risk/reward picture.
Bottom line is that I think I would be more comfortable with a higher strike for FEB, but not so high as to risk losing if called out. FEB15 is a no lose threshold (neglectinng fees and bid-ask spreads), and has high probability you will make at least 20-25% if it goes up. Dropping back to FEB12.5 or FEB10 guarantees a healthy gain if it goes above 20, but increases your downside risk.
I'm sure all these numbers are not the easiest to follow. There is no way I can give you the visual impression you can get from looking at the graphs yourself. I think it would be well worth your effort to get a good strategy analyzer so you can compare the alternatives. I've certainly improved my understanding of how these thing evolve since I got my hands on one.
Dan |
