Reduced-Risk Trading
The following is from the book Options Essential Concepts and Trading Strategies, second edition. It's published by The Options Institute: The Educational Division of the CBOE.
The book can be found in most bookstores. I got my copy at Amazon for a 30% discount. The author of this chapter Harrison Roth also wrote LEAPS, another excellent book. Greg Higgins recommended both books on post #1 of this thread.
Here's the quote:
Reduced-Risk Trading
For the scalpers and market pinpoint-timers, there is a wonderful option strategy available. Start by buying a combination - equal quantities of puts and calls on the same underlying stock, with the same expiration month, but with different strikes. These will usually consist of a call strike above the market price of the stock and a put with a strike price below it. This technique is well known: traders use it to profit from a large stock move in either direction. The strategy can also be employed in a slightly different fashion.
Assume that after your double purchase, the stock moves down to below the put strike and then hesitates. If you believe it is about to turn up, you could buy stock at that point. If your assumption is correct, you could sell the stock at a point when you thought it would again reverse its trend. If you were wrong, the risk was limited because you could always exercise the put. Similarly, if the stock first rose, you could short it, then buy it back while being protected by the long call. If you are able to get off a couple of good trades, you will probably recover the original cost of the combination. Once that has happened you will be in the stance of having no money invested, and being able to trade back and forth while always being protected.
I modified this strategy by purchasing a straddle on ONSL, instead of a combination and trading the 24.50 - 28.50 ranges. According to the book, the combination would have been $30 call, and $25 put. But the maximum profit range with ONSL is $28.50 at the top, so I settled for the straddle at a higher cost.
I opened the position at the low end of the trading range on 07/14/1998. It has since climbed to 29.00 and my position was reversed, now it's heading back down. I'll need three trades to get a risk free position. Then it's blue-sky profits all the way! Here are the numbers:
Bought 1000 shares @: 24.50
Bought 10 Dec 25 call: 4.75
Bought 10 Dec 25 put: 7.00
Long roll range: 24.50 - 28.50 (4.00 per roll)
Short roll range: 28.50 - 24.50 (4.00 per roll)
If this stock repeats the channeling pattern of the past two months, I should generate about $16k per month. Once it breaks out of it's channel, the max loss I can incur before closing the position will probably be around $5k. That still leaves $27k on the table -- more than double my investment in only two months! Of course, the stock can continue to roll right through December, in which case I shutter to think about the potential profits.
The big risk: the stock breaks the channel to the downside immediately after I enter the position. That would be a $9k loss on immediate breakout, (it hasn't), a $5k loss if the breakout happens after two trades, and ZERO RISK after three trades!
I'm also playing with a further modification to this strategy that will let me juice this baby even more, but I'm not ready to share it until I've thought it through and back-tested the idea. If it works out, then I can be risk free after only one trade, maybe two.
If anyone is interested in how this play works out for me, post to the thread and I'll be happy to share the results with the gang. |
