Profile,
First things first. As for TOL or the OIH or AAPL, as in any stock, calling a top or a bottom is a dangerous proposition. People love to call tops and bottoms, it feeds the ego; it empties the bank account. I always wait for a stock to prove that it has changed its short term, medium term or long term direction, then I react to it. As I noted on another board, the Prudent Speculator has been calling tops in the homeboys for over 2 years, as many as 24 calls. This last one they may have gotten right, at least as to an intermediate (4-6 week) pullback. Batting one for 24. I'm not interested in ego plays, I leave them to you.
As for FNM, you have gone to great lengths to analyze the position without looking at the underlying theme of trading a reasonable, even conservative, directional play with a low dollar amount and limited risk of loss. It starts with a view of where FNM has been, already is, and is likely to go, and a willingness to accept the risk of that view. The goal is to profit from FNM's continued fall. For an entry price of $3, the position is currently $5 in the money. Breakeven is $2 above the current downtrending price. As a speculator, I always appreciate the big play, but also the careful use of capital. I wish to participate in the continued downtrend of FNM on conservative terms. Risk is absolutely capped at $3. If the stock suddenly gapped up overnight to $65, those who shorted 2,000 shares of stock would be subject to a $20,000 loss, something a put spread does not risk. In fact, $3 value in the put spread would not, depending on when the skyrocket took place, have to be extinguished.
(By the way, I fully expect FNM to pull back $2-3 at some point in this trend, could be here or a dollar lower.)
Could it continue to fall, even plunge? Yes. Could it stop? Yes. Could it rise? Yes. Could it skyrocket? Yes. No free lunches. But I like the play, time is on my side, and since maximum risked (and capital charged) is $3, then I think $6,000 is the appropriate risk number to use, not $110,000. Of course, all of that $6,000 is at risk, although realistically, the long puts could be worth more than the differential as time goes by, and then there are numerous opportunities to play out different scenarios as the months go by, including rolling things out, repairing one or the other part of the spread, the possibilities are almost without limit. (Looked at from $110,000 point of view, maximum absolute risk is 5.5%, maximum gain is 3.6%, but that compares favorably with many of the successful trades that DB closes, when you compare the actual cost of risk capital to making the play, and when you remember the absolute risk involved with shorting stocks.)
It's a question of probabilities, and I suggested it as an alternative to DB's straight shorting idea for people to think about. A straight short of 110,000 shares incurs many risks, the uptick rule, overnight gaps in the wrong direction, and a large capital cost. I think the probabilities favor FNM trading in the 55-50 level by June. I think it's a lower probability that it will trade sub 50 at that time. I think it's a lower probability that it will trade much longer in the 55-60 level from now on, but I'm not worried about April or the beginning of May. So I'm buying the probability, already in the money (60 puts) that I believe most strongly in and I'm cutting the cost of that view (hedging is another way to put it) a lower probability play, the below $55 level.
If I'm trading a commodity such as apples and I can get comfortable paying $300 now for something I feel I have an excellent chance of receiving $500 for in June, do I do the trade? Or do I pay $600 (unilateral calls) now for those apples that have an excellent chance of paying me $500 in June, but only a so-so chance of paying me up to $1000 in June? Do I take the "surer" 66% return, or play for the more risky "minus 17% (-$100) to 100% (+$1,000)" return?
Kb |
