A little capital campaign.
My speculative (I can't really call them investments anymore, the whole portfolio returns an investment, but each individual play is a speculation) activities have undergone a bit of a metamorphosis in recent months. One interesting turn of events is to consider each position, or set of positions, as a mini capital campaign.
I undertook one recently with US Steel. My thesis at the end of April was that X was a downtrending stock whose downtrend was likely to continue. I projected that (on April 25 when it was trading down from $48.16 high to a 44.51 close) it would likely trade below $40 sometime in the summer. My "campaign" to speculate on this outcome tried to use capital responsibly and get hedged as soon as fiscally sound. With that in mind, I did the following:
4/25 BTO X Jul 45 puts at $3.50
(Legging in, for 2 days I have a full $3.50 at risk.)
4/27 STO X Jul 40 puts at $2.50
Now I have exactly $1.00 at risk and I "own" the July 45/40 put in X. 5 to 1 reward: risk ratio (well, 4 to 1 if you just look at reward to capital at risk).
Time passes and X rallies. The X Jul 40 puts I sold for $2.50 are now worth only $1.60, so I bought them back:
5/6 BTC X Jul 40 puts at $1.60
I now have $2.60 at risk in the trade (-3.50, +2.50, -1.60 = $2.60).
Today as X completes a 2 day fall from grace, I sell the July 40s again:
5/10 STO X Jul 40 puts at $2.70.
I now have a 10 cent credit on the trade and it still could pay off $5.00 per share.
Depending on what X does, I have a few choices. If it breaks down here and trades down to $40 and channels, I can just wait it out and collect my $5.00. If it continues to drop and rally, I can buy back the puts on the next rally for perhaps another $1.60. That would leave me with $1.60 of exposure in the trade, but on a future drop and resale at, say, $2.60 could put me in the enviable position of owning the $5 spread for a credit of $1.10. Minimum gain of $1.10, maximum gain of $6.10.
How to calculate capital at risk? Back of the envelope method makes me take the amount of capital at risk times the days it was out there, divided by total days, or now about $1.70. Of course, the longer (days) I sit with a credit, that is "negative capital" at risk, the more it drives down the average daily cost of capital. For example, there are 66 days left to July expiry; if I simply hold this 10 cent credit position to the end and the stock closes below $40, then my return will be $5.10 on an average capital cost of 23 cents, or 2217% return on capital.
Otoh, if X goes to $46 and strands me with the 10 cent credit, then I've received 10 cents for a 23 cent investment, or 43.5%. After putting in commissions, not a very great return, but guaranteed no loss.
Fun with numbers.
Kb |
