Tim, My protection against sharp downturns is the rollout. Four benefits:
1. Larger premium, reducing break-even point
2. Delays day of reckoning, giving time for stock to recover.
3. Opportunity to roll down to lower strike price
4. Potential to repeat rollout again & again
Example: Suppose I sold 10 Dell 8/130P on 7/17 for $16. The premium is now 21.00; I'm $5 under water. What to do?
Buy the 8/130P back for a 1998 loss, then sell my choice of:
2/99/130P for $31 [$10 gain]
2,000/130P for $38.50 [$17.50 gain]
2001/130P for $44.12 [$23.50 gain]
Only 5 2001/130P cover the $21 buyback, and there's still a small gain. Or, roll out and down and fewer: Sell eight 2,001/110P for $28.50. 3 benefits: lower strike, fewer contracts, 28 months time distance.
Suppose Dell's troubles are temporary, it climbs to $150 by December: Premium for 2001/110P which I sold for $28.50 will be about half. I can buy those back and sell a closer put for a higher premium, reduce the wait till I'm in the clear: a rollback & up.
Of course there are numberless other combinations, Tim. Let's suppose the 8/130s are put to me when Dell is 115 next week. Now I can really get fat: My net cost on the stock is $130 less the original $16, or $114
Then I can sell the 2001/130 straddle for about $79.
Net out of pocket is $114-79 = $35.
Assume the stock is called in 28 months at $130.
Profit is $95, which is about $115% annualized gain: total gain 271%.
In the meantime, as the stock went up I close out cheap puts and sell ones with higher premiums to eliminate the $35 cost.
My problem is: will Dell go up in 28 months? I'll accept that risk.
In the last 28 months Dell went up 3,600%
Hope this helps, Tim
Don Martini
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