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

To: edamo who wrote (111868)	3/24/1999 7:16:00 PM
From: Chuzzlewit	Read Replies (1) \| Respond to of 176387

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

To: edamo who wrote (111868)	3/24/1999 7:51:00 PM
From: Marq Spencer	Read Replies (2) \| Respond to 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 + 12055 - 10030 = $12130 My holdings are worth 30 + 22055 = $12130 2. Dell is at $25 at expiration: Your holdings are worth 8530 + 12025 - 10060 = $5530 My holdings are worth 30 + 22025 = $5530 3. Dell is at $85 at expiration: Your holdings are worth 8530 + 12085 - 0 = $18730 My holdings are worth 30 + 22085 = $18730 4. Dell is at $0 at expiration (worst case scenario <vbg>): Your holdings are worth 8530 + 1200 - 10085 = $30 My holdings are worth $30 + 2000 = $30 5. Dell is at $100 at expiration: Your holdings are worth 8530 + 120100 - 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