Today's Option Lesson.
William, thanks for your reply...I have an options question for you, and everyone else for that matter...I read about a bull put spread... sell Dell November 80 put at 3.25, and buy the Dell November 55 put at 0.75. This trade will net the difference between the two prices which is 2.50. If the stock remains above 80 per share until November, both options will expire worthless. If the stock is trading below 80 when November options expire, you will have to buy the shares. And in this case, the actual cost would be $80 - $ 2.50 = $77.50 ... what do you think...?
Ask yourself this question. Would you be willing to lose $22.50 per share. This is the maximum THEORETICAL loss for the above scenario (but see example below), if Dell would drop below 55 at expiration, and assuming you maintain your position. You're selling the puts because you believe Dell will be higher at expiration, and you want to keep the premium. You're buying the lower put to limit your downside to $22.50 per share. If Dell drops below 80 and you are assigned (rare before expiration, but it happens - this is another risk! - You will have to pay $80 a share. If it drops below 55, then you get to take your shares and put it to someone else for 55. But wait a minute! Something bizarre happened! The market is real jittery in October. That's when the big crashes occur, when they do occur. Dell drops to $40 a share! People panic. The person that bought your put sees that there is no time premium left, because it's so far in the money. In fact, because of the big bid/ask spread, it would actually be cheaper if he exercised the put you sold him, and so he does. Then you get assigned. You thought you had until expiration, but no, you've already been assigned and it's only October, but your broker was dilatory in notifying you, or you decided to go on a nice vacation, and so you weren't around to do anything. You thought you had until November. Suddenly the market turns around. It starts to rise. Dell rises back up past $55 per share, never to go back down again. But you're not sure. You think maybe it might, and so you wait until expiration, when the puts that you still own become completely worthless because Dell never went back down! So you didn't even get a chance to get what was left of the measly time premium. Oh my God! You thought your maximum loss was $22.50, but it turns out that now your actual loss is $37.50 per share! You just didn't foresee this happening! Your broker issues a margin call. You file for bankruptcy, your house is foreclosed, your wife divorces you because she doesn't want to be associated with a loser, your children, ditto! And then, many years later, after it was all over, you sat down at the street corner just as you have done for years as a homeless person, and you asked yourself, "Why did I do it? Why? Why, God? Tell me why?"
And God answers, "Because you wanted to make $2.50 a share!"
You reply, "But I was so sure, God, I was so sure!"
"Of course, you were!" said God. "Otherwise you wouldn't have risked so much for so little!"
Of course, this is an unlikely scenario, but a definite possibility. The trade would probably be profitable since it is unlikely that Dell will drop below 80 by November, unless earnings come in less than expected or there is a big meltdown in October, something which you can't know for sure, although I am sure many here will think otherwise. The thing to keep in mind with trades like this is that your maximum profit is $2.50 a share, and no bizarre scenario can increase this by one iota. Your maximum theoretical loss is 9 times greater, $22.50 a share, but your actual loss can even be greater than this, depending on how you close your positions, as you can see in the above scenario. IMO, it's not worth the meager profit.
Forget options! You don't know enough about options to really be doing any. They're high risk, and there are many possibilities, some of them quite complicated. Also, I can't give you a lesson here, nor do I have the time. Before you can ever really make money at options, you have to be a good market timer, unless, of course, you're buying LEAPS. You have to have a good idea of what the market and the specific stocks you're looking at are going to do. If you don't, you're probably going to lose. So you have to learn more than just options. If you need to dabble in options, just buy LEAPS on Dell in mid-January. That would be a good investment. Don't buy them now, because you'll lose a lot of time premium while Dell trades sideways for the next 5 1/2 months. That's the best time to be in the market, from mid-January to mid-July; after that, profits, especially in buying options, are much less certain. |
