Kodiak Bull, you're assuming that FNM stays below $57 by June. You are basically selling time and being boxed hoping that the rise of FNM is not greater than the net premium you receive.
To correctly illustrate the pitfalls of this strategy, look at the scenario you encounter:
If FNM closes at $55/sh on June expiry, you keep the $3.4k you collected in selling the June 55 puts and you are not assigned any june 55 put stock long since the price is at the strike. I assume you also cover your short stock assigned via your June 60 long put at $55, but you lose $1.40 in premium paid ($6.40-$5.00). Therefore, you make $2000 ($3400-$1400).
At $60/sh at June expiry, you keep the $3.40 from selling the June 55 puts and subtract the $6.40 loss you took on the June 60 put, losing $3,000.
At $50 per share, you keep the $3.4k, make $3.6k dollars on the June 60 put ($10 ($60-$50) minus $6.4 paid for the put) for a subtotal of $7000 dollars, but take a loss of $5000 on the June 55 put assigned to you for a net $2000 gain.
All of this because you are looking to protect the spread acquired by selling time on the put, since there was virtually no time purchased on the deep in the money put.
Your best case scenario involves FNM not going over $57 by expiry (break even point) and preferably staying at or below $55/share to protect your $2000 potential profit. If it does go above $57/sh., you lose money. Also, the return needs to be really calcualted using the asset base involved. You are making $2000 on $110,000 worth of stock (assuming 2000 shares of FNM at ballpark $55/sh., both long and short, over 3 months. That equates to a 7.47% annualized return at best, which is not very impressive if the stock cannot rise by more than $2, or 3.64%. This is not a sound strategy unless you are convinced of the downtrend and that the stock cannot do a TOL of sorts (TOL is now down $14.94 since you called me a bunch of stuff which I would rather avoid rehashing).
The question is basically how do you manage risk with your put spread. It is simple. Your annualized return is cut in half if the stock goes to $56, or it goes to 3.64/2 or 1.82%. For that kind of unforgiving scenario, I would stay out of the trade or altogether sell the puts in a month that is farther out and buy the shorter term puts. That laddering will allow you to keep more premium from the put sale while going short with less time premium. With a market that has such low volatility to be sold, I would not do this personally.
But if you really believe in the downtrend (or uptrend) simply buy the stock, call, or short the stock, buy the put. There is no silver bullet otherwise everyone would be a millionaire with this strategy by now. |
