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Technology Stocks : Dell Technologies Inc.
DELL 122.55+4.4%Nov 21 3:59 PM EST
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To: edamo who wrote (111868)3/24/1999 7:51:00 PM
From: Marq Spencer  Read Replies (2) of 176387
 
ed a:

I think that the downside risk for your method is identical to going long, and the upside profit is limited if the underlying moves above $85. Let me try to understand/explain (ignoring commissions):

You have $8500 in cash.
You write 1 ZDEMQ ($85 put) for $4650.
You buy 120sh Dell @ 38.5 for $4620.

Your holdings:
Cash $8530
Long Dell 120 sh
Short 1 ZDEMQ ($85 put)

My approach: Buy 220sh Dell @38.5 for $8470.
My holdings:
Cash $30
Long Dell 220 sh

Now let's look at some scenarios:

1. Dell is at $55 at expiration:

Your holdings are worth 8530 + 120*55 - 100*30 = $12130
My holdings are worth 30 + 220*55 = $12130

2. Dell is at $25 at expiration:

Your holdings are worth 8530 + 120*25 - 100*60 = $5530
My holdings are worth 30 + 220*25 = $5530

3. Dell is at $85 at expiration:

Your holdings are worth 8530 + 120*85 - 0 = $18730
My holdings are worth 30 + 220*85 = $18730

4. Dell is at $0 at expiration (worst case scenario <vbg>):

Your holdings are worth 8530 + 120*0 - 100*85 = $30
My holdings are worth $30 + 200*0 = $30

5. Dell is at $100 at expiration:

Your holdings are worth 8530 + 120*100 - 0 = $20530
My holdings are worth $30 + 220*100 = $22030

Actually, to summarize, at any price point between 0 and $85 inclusive, the value of the two holdings is identical. However, for every dollar above $85, my holding outperforms yours by $100 (as I have 100 more shares working for me while your short put contract stops working for you).

So, the risk is identical to going long. The rewards are limited in the case of extreme upside.

BTW, the reason why this is the case with your example is that you have such a deep in the money call that there is no time premium attached to it. If the put is closer to the current price, you can get a premium that will limit your risk to some degree (as well as your gain).

- Marq
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