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Technology Stocks : Dell Technologies Inc. -- Ignore unavailable to you. Want to Upgrade?

To: AlanH who wrote (44504)	5/23/1998 9:58:00 AM
From: Richard Forsythe	Read Replies (1) \| Respond to of 176387

I think the put-writing strategy works as follows. First, imagine you own 1 contract of DELL november 150Puts. These are 'deep in the money' -- apart from the time value, they are worth the difference between the stock price and the share (about $65 today). If the share goes up $1, the option comes down $1 (per share), and vice versa. If you want to own that option "risk free", you would buy 100 shares DELL and also 1 Nov 150 Put. If the stock rises (a bit), you make on the stock what you lose on the option and vice versa if the stock falls. By November, you have lost the time element of the option price, but otherwise you are even. There is problem that arises when puts are not deep in the money (e.g. the put is a NOV55 with DELL at 85) -- the share and the option do not change $ for $. In fact, the 'delta' for the option tells you how much the option will move. This is about -0.1 for the NOV55P. So if you buy 1 contract Nov55 puts, you need to buy about 10 shares to zero the risk (because the option will drop $.10 per share for a $1 rise in DELL). In addition, if DELL falls, say to 80, the delta increases (to -.12) and you need to buy a couple of shares to keep the balance. Thus, if some bank is holding 35000 contracts (ie options on 3.5 million shares) they have probably also bought 350000 shares on the market to hedge the risk. AND (here's the really good bit), if DELL drops to $75 they need to buy another 175000 shares (as it drops) to ensure they don't lose money. $65 requires them to hold a total of 875000 shares and if it hits $55 they must own 1.34m shares. If the stock were to drop to $33 or so, the bank would have to own 3.5m shares of DELL to avoid losing money. As you can see, this situation creates a guaranteed buyer in a market decline (although a guaranteed seller in a rising market), and so will act as a support to the stock until November. If the worst happens and the stock plummets despite 3.5m shares being acquired by said bank, then DELL can simply pay the $55 and buy the stock for its repurchase program anyway. The only remaining question is: "Why would a bank buy the options just to manage away the risk through buying shares?" My best guess is that DELL paid them a fixed fee (that covered the option premium, as well as the bankers' salaries etc) to do this. They then can calculate the costs (including the lost premium), book the revenue and maintain a zero risk portfolio through November. Richard