kjb1891,
Yes, I have done them before. Funny you should mention them as I agree they are rarely ever talked about.
In general, I think they are best for when a stock is not likely to stay in a range for a long time and then you do this spread with quite a bit of time left - remember that just like with a straddle you can do a "time" stop loss.
An example of what I did was when NOV was around $80 (Pre-split now I think - this was back in 07 I think), I did 90/100 Bull Call Spread and the 70/60 Bear Put spread. If possible, personally, I like going a bit closer on the put side (not that this example was). Later, NOV went to around $115 range and I closed for a proft.
However, there are some pitfalls -
1. 4 Bid/Ask spreads (buying and selling)- this can add up quite a bit - I would only consider these on options that have solid b/a spreads.
2. Limited profits - Of course, only one side can go to full value at a time - of course, a person could consider holding the other side in case of an extreme reversal, but it's not likely. In general, if you pay $600 for a 10 point spread on each side, you know you are limited to $400 max profit.
3. Hard to know when to take profits - in my example, there was about a month left on my options, and I was risking it falling below $100 again, so I closed out, but there was still some time values left in the short positions, so I didn't make as much as I could have if I had waited it out.
On the other hand, compared to a straddle/strangle, these can:
1. Cost less money up front.
2. Have better break-even at expiration points (yes I know, that's only at expiration).
3. Have the same % gain with smaller moves or even turn what would have been a small loss with a straddle/strangle into a small gain.
Just as example for anyone reading:
Stock - $90
100 Call - $800
110 Call - $520
90 Put - $800
80 Put - $520
Lets say the options are about 4-6 months out.
Strangle would cost $1600
Reverse LIC - $1600-1040 = $560
Stock at 107 @ expiration:
Strangle = $700 = $900 loss
RLIC = $700 = $140 gain
Again, this is a very pro-RLIC example and only good at expiration.
I think most people don't trade these because people who do trade straddles don't like the idea of limiting their gains.
In general, if I am looking for a candidate for doing this with I look for:
1. Stock that I don't see being exactly where it is 4-6 months from now.
2. Good Bid/Ask spread and liquid obviously.
3. Enough value in the farther out of the money options to make it worthwhile to sell those - if the options in the example above that were sold only brought in say $330, now you wouldn't want to do that.
4. It's OK IMO if earnings is coming up as long as you don't expect IV for 4-6 months out to get crushed - earnings can make the stock move quite a bit. If earnings just came a bit ago and IV is low that is OK as well.
5. Normally I would only do this with higher-priced stocks and use 10 point spreads on stocks over $50 and maybe 5 on stocks from 25-49. I guess a person could consider 2.5 point spreads on lower priced stocks.
I would normally look to close this position with somewhere around 1 month left, though it probably depends on the IV of the stock as well. In general, you would like to keep any loss to 50% at least, as your gains aren't expected to be huge.
Also, I would consider closing the position anytime you have a decent gain such as 25-40% depending on your goal. Remember that the most you can ever make will be limited anyways.
One more point - if the side that is almost worthless truely isn't worth selling then I would keep it, but if it adds to the gains much at all, I would sell as it is very unlikely to do any good. For example, if you paid $600 for this and can now sell the Call spread for $800, but the put spreads only bring $5, not worth selling IMO, but if they still bring say $40, then I'd probably sell.
JJacksET4
