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Hi Prosper,
There is nothing wrong with any strategy as long as
you understand the possible risks and rewards:
This strategy is short term neutral to bullish
and long term bullish. First, the proceeds from the short puts help
reduce the cost (break-even) of the long stock, so you have some
limited down side protection on the stock. The rewards for being
correct are very good but you carry a HIGH RISK if you are wrong.
There are several possible outcomes:
1) If the stock goes up in price
you will profit in two ways, the put will expire (you keep the premium
received) and the gains in the stock.
2) If the stock remains close to
the put's strike price, the time premium will go out of the put as expiration
approaches. You can then buy back the put for a profit and, if you chose,
sell another further out in time. Selling another put will
further reduce your break-even on the stock.
3) If there is a small drop in
the stock's price, you will need to decide whether to buy back the put at a
potential loss or allow it to be exercised. If exercised you will be
required to purchase 100 shares of the stock at the put's strike price for
each contract sold. This is not necessarily bad if you are confident in
the longer term potential for the stock. Note, you will be required to
have sufficient cash or margin to cover this possibility or your broker will not
allow you to sell the puts naked.
4) If the stock undergoes a major
drop in price, volatility will increase and the price of the put will jump as it
moves into the money. Thus you will be faced with a double loss, the loss
in the stock price and the high cost to buy back the put. Allowing the put
to exercise will also double the loss.
As a general rule I prefer to use options to
reduce risk at the expense of maximum potential profit. This trade
maximizes the reward but carries a high cost if you are wrong. If you have
a particular stock and option in mind let me know ant I will chart it for
you.
God yuck and good trading,
Ray Raffurty
<BLOCKQUOTE
>
----- Original Message -----
<DIV
>From:
<A title=prosper1000@xxxxxxxxx
href="">prosper1000
To: <A title=realtraders@xxxxxxxxxxxxxxx
href="">realtraders@xxxxxxxxxxxxxxx
Sent: Wednesday, March 26, 2003 2:10
PM
Subject: [RT] What is wrong with this
option stratagie?
Let's say that a security has been going up and it has
leveled off and it has fairly high volatility. So I sell an at the money
put, then I turn around and buy the underlying security. You thoughts
appreciated.To
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