I don't think that we have to limit ourselves to just one option strategy. But do you realize that the strategy that PAL was suggesting doubles your risk on the downside and provides only a limited upside gain?
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Note at the bottom of the screen where it says- Maximum Loss: Open.
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A covered straddle amounts to taking a covered call position and doubling your exposure by selling a put without providing for any better loss protection beyond what the extra premium brings you.
I still believe this is misleading. The maximum loss associated with a covered short strangle is Current Price + Strike of Put - Premium of Put - Premium of Call. That is not unlimited loss. It is not even double exposure. The exposure is precisely the exposure of the covered call (Current Price - Premium of Call) plus the exposure of the short put (Strike of Put - Premium of Put). The strike price of the put can be chosen to be very low and that limits the additional exposure to well below double. For example (and I'm not advocating that anyone do this):
CSS:
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Buy 100 NTAP @ 13.91
Sell 1 Jan-02 15 Call @ 3.2
Sell 1 Jan-02 10 Put @ 1.5, backed with cash
Cash out: 1391
Cash in: 320 + 150 = 470
Capital required to back put = 1000
Total capital requirement = 1391 + 1000 - 470 = 1921 (significantly less than double exposure)
Maximum gain = 1500 - 1391 + 470 = 579
Maximum loss = 1391 + 1000 - 470 = 1921
Gain if NTAP unchanged = 470
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Two CCs:
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Buy 200 NTAP @ 13.91
Sell 2 Jan-02 15 Call @ 3.2
Cash out: 2782
Cash in: 640
Total capital requirement = 2782 - 470 = 2312
Maximum gain = 3000 - 2782 + 640 = 858
Maximum loss = 1391 + 1000 - 470 = 2312
Gain if NTAP unchanged = 640
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The period ROI if NTAP is unchanged on the CSS is 24.2% and on the two CCs it is 27.7%. The maximum period ROI is 30.1% for the CSS and 37.1% for the two CCs.
However, if NTAP finishes at 10 the return for the two CCs is -182 and for the CSS it is 79. This means that the breakeven for the CSS is lower than the breakeven for the two CCs. So unless I've screwed up somewhere, this particular CSS is actually MORE CONSERVATIVE and LESS BULLISH than these two CCs.
Keep in mind that I chose these positions at random and it is only one data point. However, my gut tells me that by adjusting the relationships between the strikes of the options and the price of the stock, one can make the CSS either more conservative or more aggressive than a given CC.
For Dan and anyone else who cares, the appropriate quantity to look at seems to be the following ratio: (Strike of Call - Current Price)/(Current Price - Strike of Put). The higer this ratio, the more aggressive the CSS. The lower this ratio, the more conservative the CSS. Somewhere near 1, the CSS is equivalent to two CCs.
Oh, yeah, you can also use margin to tweak any or all of the above to your liking. :)
At the risk of being unpopular (and incorrect), I still think some of what PAL said is valid. It is unfortunate that he was unprepared to back his comments with anything other than rude chest thumping. It seems to me that the source of much of the frustration is that both CCs and CSSs can be applied flexibly so that one can be made more bullish than the other and vice versa. Also, margin further complicates things. Then again, the use of margin is always optional (pun intended). ;)
I guess the bottom line is that it seems to me that the two strategies are equivalent since a position in one can be replicated using the other. (Can Dan or someone prove/provide a counterexample?) If this is true, any discussion about which strategy is superior has little hope of ending well. Maybe, maybe not.
dM@DodgingRottenVeggies.com |
