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<DIV><FONT color=#0000ff><FONT size=3>OK, William... I'm going to answer
your questions embedded in the text below. Hope you and everyone can read
it OK.... I'm doing it in blue to make it stand out from the existing
text.; </FONT></FONT><FONT size=3></FONT></DIV>
<DIV><FONT size=3>>Dave,<BR>>Thank you for your expert advice and
willingness to help.<FONT color=#000000> </FONT>Here is a trade I would
like your opinion on. Two days ago, I have just<FONT color=#000000>
</FONT>started a debit bull calendar spread (Did I name this spread right?) on
LCOS.<FONT color=#000000> </FONT></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3>Yes... technically you are correct in
naming the position... however what you are REALLY doing is better explained as
a SYNTHETIC COVERED CALL, or COVERED LEAP CALL. For many new options
traders, this will make it much easier to mentally grasp. You've created a
position with a fixed and limited upside (profit) and an unlimited downside
(risk/loss). Read on...</FONT></FONT><FONT size=3></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT
size=3></FONT> </DIV>
<DIV><FONT size=3>I have a bias as to its increasing in price in the near future
due to its<FONT color=#000000> </FONT>recent stock split announcement. The
stock was trading at around $60 before<FONT color=#000000> </FONT>the
announcement, and up to $100 intraday during the announcement. It has<FONT
color=#000000> </FONT>dropped down to $65 last month. Today, LCOS closed
at $77.625. The split<FONT color=#000000> </FONT>will be reflected on
8/26.<BR><BR>My stragegy was to make use of time decay Theta. The trade
was as follows:<BR>Long a Leap call option Jan99 @ $50 strike price for $28.50
when the stock<FONT color=#000000> </FONT>price was $72 two days ago. So
the time premium was $6.50 for 5 months.<BR></FONT></DIV>
<DIV><FONT size=3><FONT color=#0000ff></FONT></FONT> </DIV>
<DIV><FONT size=3><FONT color=#0000ff>OK, so you went long a deep ITM strike
option (50 strike when LCOS was at 77-80), thereby having a very high Delta...
probably well over 95 (percent correlation to the underlying asset's price), and
also a very low Theta (rate of time decay). You've effectively bought a
proxy of the LCOS stock at a fraction of it's actual price. Good job IF
you want to be same as long the stock.</FONT></FONT></DIV>
<DIV><FONT size=3><BR>At the same time, short a call option Sep98 @80 strike
price for $5.625. The<FONT color=#000000> </FONT>idea was to take
advantage of the high volatility and premium of the Sept @80<FONT color=#000000>
</FONT>call. So my net debit was $22.875 plus
commissions.<BR></FONT></DIV>
<DIV><FONT size=3><FONT color=#0000ff></FONT></FONT> </DIV>
<DIV><FONT size=3><FONT color=#0000ff>OK, so now you've sold a call virtually
At-The-Money, thereby having close to a 50 Delta (a 1/2 correlation in price
movement to the underlying asset... moves half as fast up or down in price,
compared to LCOS stock (and your LEAP), at this stage), and just about the most
significant rate of Theta (time decay) you can get in this position.
You've sold the option with expiration in the closest available date, which is
one of my cardinal laws (broken only in very rare occasions.) If the stock
stays in a pretty close range, your short call will continue to have a healthy
daily rate of decay (Theta.) If LCOS climbs, your short option will be
going deeper ITM, and will begin to accumulate INTRINSIC premium value
(cash-exercisable value) which obviously won't decay through time. The
higher LCOS climbs, the less your covered-call spread will be able to make,
until it ultimately reaches the predetermined maximum, as you've calculated
below.</FONT></FONT></DIV>
<DIV><FONT size=3></FONT> </DIV>
<DIV><FONT size=3></FONT> </DIV>
<DIV><FONT size=3>Possible outcome of the trade: <BR>>(a) If the stock goes
above $80 before expiration and I get called out, I will<BR>>in effect get
$80 - $50 for my $22.875 investment, = a return of 31% for
one<BR>>month.<BR>><BR>>(b) Or I may buy the Sep $80 call back one day
before expiration for the<BR>>amount being in-the-money, and write a new Oct
slightly out of the money call<BR>>or slightly in-the-money call for an
additional $2 to $4 time premium for the<BR>>next month.
<BR>><BR>>(c) Or if the chart shows the stock may be declining, I shall
write an in-the-<BR>>money call.</FONT></DIV>
<DIV><FONT size=3><FONT color=#0000ff>Yes... this WOULD BE the
"plan"... however I urge extreme caution as you may have noticed the
old saying that "The markets warily climb the long wall-of-worry, and
quickly slide down the slippery-slope-of-hope." </FONT></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT
size=3></FONT> </DIV>
<DIV><FONT color=#0000ff><FONT size=3>Most traders find it very difficult to
keep their flesh attached when the sharks start attacking the bid-ask-spreads,
and we want to make adjustments in the heat of a decline. There are ways
to place limit orders using "contingent on" orders that will replace
your fading short call with a deeper ITM short call in the case of a
collapse.... but you'll still be subject to the mercy of the traders in the pits
(who are salivating as they read this!)</FONT></FONT><FONT
size=3><BR>><BR>>(d) If the Sept $80 call expires worthless by Sept 21, I
can sell the Jan99<BR>>$50 call if there is good profit.
<BR></FONT></DIV>
<DIV><FONT size=3><FONT color=#0000ff>Since you established your spread (locked
your profit parameters) and went long the J99 50 Call LEAP when LCOS was at
77... your short could only expire worthless with LCOS less than 80... and after
minimal Theta decay on your LEAP, in order for it (the LEAP) to be profitable,
LCOS would almost certainly have to be above 78-79... a pretty small target to
hit, wouldn't you say?</FONT></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT
size=3></FONT> </DIV>
<DIV><FONT color=#0000ff><FONT size=3>If you're going to want to liquidate your
LEAP at a profit, you're probably going to need to have an upward thrust above
80 to do so (because options that far forward, and that far ITM are very
sparsely traded... so the floor will tend to widen the Bid-Ask spread, cutting
sharply into your returns)... which puts you back in the boat of just simply
being long the stock (or it's proxy equivalent) without any hedging. Not
bad if you're confident in LCOS... but hardly strategically
covered.</FONT></FONT><FONT size=3></FONT></DIV>
<DIV><FONT size=3>><BR>>(e) Or I can write an Oct call and collect the
premium at about $2 to $4 per<BR>>month in time premium (hopefully, unless
the stock price drops significantly).<BR>>I shall repeat the process montly
until Jan99. Then sell the Jan99 50 call<BR>>which should (I hope)
still be deep in the money at that time.<BR></FONT></DIV>
<DIV><FONT size=3><FONT color=#0000ff>Regardless of the woes the Dow or the
S&P may see in the next few weeks or months... I'd have a hard time betting
against the growth in the internet sector... so in the long run, you're probably
not in bad shape at all to be long LCOS. One thing about holding long
options though... another of my "cardinal laws" is to sell or
roll-forward (sell and buy as a spread) any long positions 30-60 days before
expiration, to avoid an accelerating Theta (time decay.) In the case of
LEAPS as you are using them, I'd probably stretch that law to 3-4 months before
expiration.</FONT></FONT></DIV>
<DIV><FONT size=3>><BR>>(f) I would lose money if by Jan99 the stock drops
to below $50 + my net debit<BR>>less the monthly time premium I collect every
month, which loss is possible<BR>>due to the volatility of the internet
market. Right? But I don't know how to<BR>>evaluate
that.<BR></FONT></DIV>
<DIV><FONT size=3><FONT color=#0000ff>Forget the "by Jan99"
business... in this trade, whenever LCOS drops to have your spread re-sellable
for less than you paid for it, YOU ARE LOSING!!! Covered Calls are NOT for
schizoid markets!!! If this baby dumps and you're not prepared... your
trade goes right along with it.</FONT></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT
size=3></FONT> </DIV>
<DIV><FONT color=#0000ff><FONT size=3>EOD closing print today on LCOS is 34 1/4,
post-split. That's 68 1/2 pre-split. I'm afraid to say it, but I'd
predict your spread is already in the red.</FONT></FONT><FONT
size=3></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT
size=3></FONT> </DIV>
<DIV><FONT color=#0000ff><FONT size=3>Again, I don't think it's bad over the
long run... but you've got to take some quick defensive
action!</FONT></FONT><FONT size=3></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT
size=3></FONT> </DIV>
<DIV><FONT color=#0000ff><FONT size=3>What you actually do is, of course, going
to be up to you... and you will be the one who profits, or suffers the
consequences... below are a few things to consider, but I can't make any
recommendations AT ALL because I'm at a bit of a loss to the specifics of LCOS
history, news, and temperament... and I'm not sitting in YOUR
gut/mind.</FONT></FONT><FONT size=3></FONT></DIV>
<DIV><FONT size=3></FONT> </DIV>
<DIV><FONT color=#0000ff><FONT size=3>Some of your options;</FONT></FONT><FONT
size=3></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT size=3><FONT
color=#000000>If you think LCOS may dive a little or a lot, but ultimately come
back up;</FONT></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3>Buy deep ITM puts, 3-4 months
forward. These will equilize some of your Delta, and cover your risk in a
short-term downslide. Use these as covers on a "scalping"
basis... i.e. keep them on only until you see an "all clear" signal
that the markets have clamed down, and start marching up
again.</FONT></FONT><FONT size=3></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT
size=3></FONT> </DIV>
<DIV><FONT color=#000000><FONT size=3>If you think LCOS is going to dump fairly
quickly in the short-term;</FONT></FONT><FONT size=3></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3>Buy back in your short 80's (now 40's) and
sell ITM Sep calls (maybe 35, and/or 32 1/2).</FONT></FONT><FONT
size=3></FONT></DIV>
<DIV><FONT size=3></FONT> </DIV>
<DIV><FONT size=3>If you think LCOS is going to H&LL in a hand-basket... and
THEN coming back;</FONT></DIV>
<DIV>
<DIV><FONT color=#0000ff><FONT size=3>Buy back in your short 80's (now 40's) and
sell DEEP ITM Sep calls (maybe 30, and/or 25). Stay ready to buy them back
in when the dump stops... and you better be quick about it! The "dead
cat bounces" don't tend to hang around for the sleepy!</FONT></FONT><FONT
size=3></FONT></DIV><FONT size=3>><BR>>I don't know what other exit
stragegies I should look at.</FONT></DIV>
<DIV><FONT size=3>>And if the stock does go above $80, should I choose (a) or
(b)?<BR></FONT></DIV>
<DIV><FONT size=3><FONT color=#0000ff>That's another entire letter.... but for
now, let's look at the fact that you've established a basic spread with a
maximized, limited possible profit. You know how to place an order that
reverses your spread, and you know at what upside price LCOS offers you no more
profit... so place a contingent order to reverse the spread at market when LCOS
is at or above that price.</FONT></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT
size=3></FONT> </DIV>
<DIV><FONT color=#0000ff><FONT size=3>You know that as LCOS dumps, so does your
kid's college funds... so look at your charts (stocks or astrology or marine
topography... whatever works for you), look even HARDER at how strong your guts
are for losses... and decide at what print downward LCOS has just dug the grave
too deep. Place another contingent order to bail out at market (the wolves
are howling) when LCOS is at or below that price.</FONT></FONT><FONT
size=3></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT
size=3></FONT> </DIV>
<DIV><FONT color=#0000ff><FONT size=3>Make the two orders OCO
(one-cancels-the-other) so your broker doesn't have to freak about accidentally
getting filled both ways (don't worry, on THIS trade it wouldn't happen...
period!)</FONT></FONT><FONT size=3><BR></FONT></DIV>
<DIV><FONT size=3></FONT> </DIV>
<DIV><FONT size=3>>Would this strategy work better on OEX, SPY (what
else)?<BR><FONT color=#0000ff>Hooyyy.... that is a BIG question. We'll
save it for another time, OK.</FONT></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3></FONT></FONT><FONT
size=3>><BR>>Would this strategy work on a declining market? A
tradig range?<BR></FONT></DIV>
<DIV><FONT size=3><FONT color=#0000ff>This strategy will work best in a steady,
ranging market, OR a slowly climbing market. If you're a market
"timer" and you nail the beginning of a slowly climbing bull JUST
AFTER a sharp decline, you'll REALLY rack up the profits.</FONT></FONT></DIV>
<DIV><FONT size=3>><BR>>Thank you very much.
Sincerely,<BR>>William W<BR></FONT></DIV>
<DIV><FONT size=3></FONT> </DIV>
<DIV><FONT color=#0000ff><FONT size=3>My pleasure... and I hope it
helps.</FONT></FONT><FONT size=3></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3>Big Profits to you,</FONT></FONT><FONT
size=3></FONT></DIV>
<DIV><FONT color=#0000ff><FONT size=3>Dave Donhoff</FONT></FONT><FONT
size=3></FONT></DIV>
<DIV><FONT color=#0000ff size=2></FONT> </DIV></BODY></HTML>
</x-html>From ???@??? Thu Aug 27 18:11:39 1998
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Subject: Re: ph"Y"chological spelled without a "Y", do you know why?
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Gary,
I'm glad that your puts are working out but I hope you also realize that there
are those of us who actually daytrade as well as position trade for a living.
I personally take my work very seriously and my time is very valuable so I
would appreciate if you did not clog up the RT mail system with matters not
related to trading. May I suggest that you pick up a good book to read next
time you get bored.
Happy Trading
Dev
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