I’m hoping for opinions from people who have used a strategy along these lines. I’m new to stock options.
I buy a stock in a company and at the same time sell a Put option and a Call option. I set aside enough cash to cover the put. The call is covered by my stock purchase.
I would only use this strategy on a stock that I’d still want to buy even if it dropped to the Put price.
Example:
Apple (figures are current, in round figures, for Nov. 2, 2008)
3 month time frame.
$100 Apple share price
5.20 April 150 call
1.65 April 50 put
2.5% APY 3 month CD (yield at 3 months apx. 0.625%)
Buy 100 shares of Apple = 100*100 = $10,000
Sell 1 April 150 call = 5.20*100 = $520
Sell 1 April 50 put = 1.65*100 = $165
Set aside $5000 in a CD to cover put, interest earned = 5000*0.625 = $31.25
Total investment 10,000 + 5,000 = $15,000
Scenario 1, no change in stock price. Both options expire.
Final account balance = 15,000 + 520 + 165 + 31.25 = $15,716.25, 4.8% gain, 20.5% APY
Scenario 2, Apple rises above 150. Call option exercises. Put option expires.
Final account balance = (100 * 150) + (5,000) + 520 + 165 + 31.25 = $20,716.25, 38.1% gain, 364% APY
Scenario 3, Apple falls below 50. Call option expires. Put option exercises.
Final account balance = (100 * 50) + (100 * 50) + 520 + 165 + 31.25 = $10,716.25, 38% loss, 76.4% APY loss
Only Scenario 3 has a loss, but I’d decided beforehand that I’d buy more stock at that price anyway. So my average stock price would have dropped from $100 to $75.
Any of you have experience on strategies like this? Also, I haven’t included commissions. What should I expect in the way of commissions for selling options?
Options Answer
March 21, 2010 at 10:11 pm
OptionsXpress charges $14.95 per leg of trade. This is higher than some, but they offer order entry screens that allow you to simultaneously place multiple-leg trades like the one you mentioned.
In your example you would be charged $14.95 x 3= 44.85 to enter the trade, and another $14.95 when the stock is called away / put to you.
Ted
March 21, 2010 at 10:56 pm
Bad idea.
This will produce income in a non-trending (i.e. sideways) market. If it breaks out in the upward direction, you have incurred all the risks of loss while putting a cap on the profits. If it breaks out downward, you keep the call premium, but you are stuck with a stock that’s dropped. This is the problem with what is known as the “buy-write” strategy.
You have found a way to make it worse. By throwing in puts, now, not only are you stuck with a stock that’s going down, you now have twice as much of it! Your comments about the average cost mark you as a beginner. Sorry, but this is a beginner mistake. If a stock is going down, it because a lot of people think it has problems. True, these may get fixed and the stock goes back up. But if they don’t, what do you do? If you bought Lehman at 80, would you have doubled your investment when it went down 10% to 72. If you doubled every 8 points on the way down, you would have 10 times your original investment tied up at an average cost of between 30 and 40 for a stock that now trades for pennies. Look at all the smart people who bought the dips on Enron and look at a chart of CWTR. This strategy will make you a few bucks on dips, but sometimes when a stock goes down, it’s not a dip; it’s really going down. You have managed to combine two bad strategies.
zman492
March 21, 2010 at 11:05 pm
My first suggestion is that you use more precision in doing your calculations. As of today’s (11/3/08) the close the quotes were:
APPL stock $106.96
AAPL April $50 put – bid $1.64, ask $1.76
AAPL April $150 call – bid $4.90, ask $5.05
Also the April expiration is 4/18/09, five and a half months from now, not three months from now.
Redoing your your calculations with corrected figures:
——
2.5% APY 3 month CD (yield at 5 1/2 months apx. 1.2%)
Buy 100 shares of Apple = 100*106.96 = $10,696
Sell 1 April 150 call = 4.90*100 = $490
Sell 1 April 50 put = 1.64*100 = $164
Set aside $5000 in a CD to cover put, interest earned = 5000*1.2% = $60.00
Total investment 10,696 + 5,000 – 490 – 164 = $15,042
Scenario 1, no change in stock price. Both options expire.
Final account balance = 15,696 + 60 = $15,756, 4.7% gain, 10.4% APY
Scenario 2, Apple rises above 150. Call option exercises. Put option expires.
Final account balance = (100 * 150) + 5,000 + 60 = $20,060, 33% gain, 73% APY
Scenario 3, Apple falls to 40. Call option expires. Put option exercises.
Final account balance = (100 * 40) + (100 * 40) + 60 = $8,060, 46% loss, 101% APY loss
Only Scenario 3 has a loss, but I’d decided beforehand that I’d buy more stock at that price anyway. So my average stock price would have dropped from $106.96 to $75.21.
——
Of course, those three scenarios only represent three of thousands of different possible outcomes. Every penny change in the the stock price reduces your return by $1.00 if the stock ends up between $50 and $150, and if the stock ends up below $50 every penny below $50 reduces your return by $2.00.
I also took a shortcut in figuring out the annual yield, so my figures aren’t as accurate as they could be.
——
As far as a strategy, selling options means you are betting that you do not think the stock will be as volatile as other option traders think it will be. If you want to take that risk, it is certainly a reasonable strategy.
There are a couple of things I would do differently.
I would deposit cash to cover assignment of put options into a money market account instead of a CD. Remember in the United States equity options can be exercised any time before expiration.
I also would be unlikely to sell a put that far out of the money for that small a premium. It sounds good to say I would want to buy more at that price anyway, but consider this. If the price drops to that level you already have a large loss on your original shares, so you it would have already been demonstrated that you were wrong about the stock. Also, anything that reduced the stock price that much might cause you to change your opinion about how good the stock is. I probably would want more compensation for taking the risk, even if it means using a higher strike price.