Safer option strategies

madbrain · Nov 15, 2011

spindr0,

Quote from spindr0:

Re your put protection idea, the last thing to mention for tonight is the possibility of collaring your positions. Sell OTM calls to fund the cost of put protection (reduced cost for ATM closer to no cost for equidistant OTM strike).

I believe I couldn't sell those naked OTM calls unless I use margin, which I don't want to.

Since a collar has equivalent R/R to a vertical spread, the spread would be more desirable for opening positions, the collar for existing equity positions.

More...

Selling calls on existing equity positions would be the only way without margin.
My findings are not terribly encouraging, though. By the time I am in the situation of holding the shares, they have usually already dropped enough that the short-term OTM call premium is negligible or zero. Only long-term calls still have some value.

madbrain · Nov 15, 2011

Quote from spindr0:

Take a look at conversions. The carry cost is the cost of holding the position and explains why calls are priced higher than puts (same month/strike).

You lost me there. I did some searches on the subject, looks like I have a lot of reading to do on this topic.

madbrain · Nov 15, 2011

Quote from madbrain:

How would you choose which protective puts to buy ? 1 yr or 2 yr LEAPS ?

Jan 2013 $30 put is $4.25, Jan 2014 $30 put is $6.10
Jan 2013 $25 put is $2.01, Jan 2014 $25 put is $3.30

The only scenario where the math seems to work out is buy the Jan 2014 $25 put. Cost would be $3.30 . And expected dividend would be $3.50 . 20 cents/share over 2 years if shares stay around $30 which is 0.3% per year. Possibly more if T goes higher. 20% downside if it's $25 or below.
Quote from spindr0:

Downside risk is closer to 10% at exp, less if drop is sooner.

How so?
I would buy stock for $30 now. Pay $3.30 for the puts. Upfront investment is $33.3.
But stock has moved down to $25 or below. Stock + put is worth $25.
I would have collected $3.50 of dividends by then, if they don't get lowered. So I have $28.50 left. That's 85.5% of the original investment. Ie .14.5% downside worst case. Is this math right?

Even less iinitial position was a collar (and short calls can be rolled down to mitigate some risk).

True.

Consider cost per day for protection as part of consideration for what strike to buy:

Jan 2013 $30 put is $4.25 (99 cts)

Jan 2014 $30 put is $6.10 (77 cts)

Jan 2013 $25 put is $2.01 (47 cts)

Jan 2014 $25 put is $3.30 (29 cts)

See a pattern?

A couple.
Cost per day drops for the longer dated puts at equal strike price.
More obviously, for same-dated puts, cost per day increases for higher strike price.

spindr0 · Nov 15, 2011

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Quote from spindr0:

Re your put protection idea, the last thing to mention for tonight is the possibility of collaring your positions. Sell OTM calls to fund the cost of put protection (reduced cost for ATM closer to no cost for equidistant OTM strike).
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Quote from madbrain:
]I believe I couldn't sell those naked OTM calls unless I use margin, which I don't want to.You own the stock so the calls sold are covered. You then use the proceeds from the calls to buy the puts. That's a collar whicjh means that you have a floor below which you don't lose (protective puts) and a ceiling above which you don't make money (covered call).

My findings are not terribly encouraging, though. By the time I am in the situation of holding the shares, they have usually already dropped enough that the short-term OTM call premium is negligible or zero. Only long-term calls still have some value.

You shouldn't be waiting that long. Once the UL breaks thru the put strike, you should be contemplating where to cut losses or how to bring in more call premium long before those short term call premiums are worth next to nothing and unsellable.

spindr0 · Nov 15, 2011

Quote from madbrain:

You lost me there. I did some searches on the subject, looks like I have a lot of reading to do on this topic.

Simpliefied explanation...

Equity buyer pays for stoick. If margined, pays more since borrowing.

Put seller retains cash, receives interest. That's better for the put seller. Since the positions are equivalent,

put price + carry cost = call price

Hence, call premiums are higher.

Read about conversions and reversals and it will make sense.

spindr0 · Nov 15, 2011

Quote from madbrain:

How so? I would buy stock for $30 now. Pay $3.30 for the puts. Upfront investment is $33.3. But stock has moved down to $25 or below. Stock + put is worth $25.

I would have collected $3.50 of dividends by then, if they don't get lowered. So I have $28.50 left. That's 85.5% of the original investment. Ie .14.5% downside worst case. Is this math right?

Math is right but when I looked at it, T was $29.25 and I think you'd get 9 dividends for $3.87 That's about 11+ % (unless I got the # of divs wrong)

madbrain · Nov 15, 2011

spndr0,

Quote from spindr0:

Simpliefied explanation...

Equity buyer pays for stoick. If margined, pays more since borrowing.

Put seller retains cash, receives interest. That's better for the put seller. Since the positions are equivalent,

put price + carry cost = call price

Hence, call premiums are higher.

Thanks. I won't use margin though, just cash account. And interest collected on put premiums would be very close to zero at most brokers currently. Of course, that can change over time. But currently, it should not be a very important factor.

Read about conversions and reversals and it will make sense.

Will do.

madbrain · Nov 15, 2011

Quote from spindr0:

Math is right but when I looked at it, T was $29.25 and I think you'd get 9 dividends for $3.87 That's about 11+ % (unless I got the # of divs wrong)

Yes, I rounded up the stock price by mistake, was too lazy yesterday.
I didn't count the exact number of dividends either, I had calculated the dividends using the current yield %.

Seems like it isn't that bad of a trade, if I think T will appreciate over the next 2 years. I didn't calculate the break-even point. I don't really have an opinion on the long-term direction right now. But I certainly hope their merger with T-Mobile gets nixed, and that it happens soon. A good time to enter would be after the bad news hits and the shares go down on the news.

Still, I would be much happier using a collar with some other security. I prefer to own indices than specific stocks. I will look at SPY collars. Maybe EEM or IWM.