David,
I have to assume that since I'm the only one who responded to jt's original question about the CSCO spreads that I'm the one you think has failed to "set him straight". I don't know who around here has appointed themselves an expert, but some of us have taken the trouble to look at options strategies in an attempt to make a realistic assessment of the risks and potential rewards. It is very true that the risk associated with options is not the same as the risk associated with stock ownership, and for that reason financial institutions want to be sure you are aware of those risks. If misused or misunderstood options can be a much quicker road to losing your capital than stocks. On the other hand, when properly used and understood they provide superior protection against loss while providing comparable profit potential to stocks. The purpose of this thread is to help achieve a better understanding of the risks and rewards.
jt framed his question as an inquiry about strategies one might employ for a stock that he felt somewhat bullish about. He did not ask anyone to judge wether the stock deserved that opinion, which by the way would not have been in keeping with the stated purpose of this thread. There are other places to go to get help assessing the likely direction or range of movement of any particular stock. So let's focus on the strategy and revisit the scenario.
The following are not the prettiest charts in the world, but they show price movement of CSCO and the two options I said I preferred for the diagonal spread:
CSCO
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2003JAN15 call
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JUL17.5 call
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(If you don't look at the chart today, you will have to change to the 6 month time frame to see the entry date)
At the time of the analysis, CSCO had just closed slightly above 17, and the debit to enter the spread was $2.55. Five trading days later, CSCO touched 14.25, down nearly $3 from the low and close on the analysis date. In that same time, the long calls had fallen about $2 in value, and the short calls had fallen over $1, so while the stock owner was looking at a near $3 loss, and struggling with with whether to hold on or stop out, the spread owner was down about $1 and starting to think about buying back the short calls at a profit, raising the total risk for carrying the long call to about $3.50 with months to go before those long calls would become worthless, and with the hope of selling those short calls again at a better price. A few days later those short calls could have been purchased for less than $1 and late last week they could have been sold for well over $2, reducing the net cost of the spread to about $1.50, or the long calls could have been sold for about $5 to take roughly a $1.50 profit.
So who is better off, the investor who bought CSCO outright and stopped out below 14.50 to protect from further loss, or the option investor who understood how to set up the spread to limit the downside risk and be positioned to realize a profit even if CSCO only manages to hold on to 17? Maybe CSCO will bounce again, and run into the 20s making stock ownership more profitable than the spread, but so far I'd much rather be in that spread than owning CSCO stock.
Dan |
