edamo, I told you I was confused, and my previous post proved it. The risk is in the price of the stock dropping. Suppose the price of the stock dropped to 0. You will be left with $30 of your original $8,500. Now suppose instead that you held the cash. The maximum risk is $3,850 per share. In essence you are betting that the price of the stock will rise to at least $68 (which is your break-even point). 125 shares @ 68 - 100 shares @ 85 = 0. That is to say that in order for this position to make money the underlying stock must appreciate at the rate of 38.4% per annum. That position is a 0 return to you.
Now if the stock rose to $85 the put expires worthless and you get to pocket $10,625 per contract. That works out to an annualized rate of 58.8%. In the meantime, the underlying stock has risen 57.2% per annum.
Based on this, the risk reward characteristics of this approach is questionable. Of course, I may still be confused, but it seems to me that you incur a fairly substantial risk if the price of the stock does not move sharply higher. Suppose, for example that the price of the stock is exactly where it is today: $38.50. Now on expiration you get $4,620 (125*38.50) which is break-even for the stock purchase and is irrelevant, so the position lost $8,500-4,620-30 = $38.50 per share. Below that point you will lose $125 per point drop because of the highly leveraged position.
But I am tired, and could have easily made a mistake. I await your critique.
TTFN,
CTC |
