Buying a put in the money potential loss and profit?

Question

I want to make the following trade using options. Can you tell me my potential profit and loss?
Stock trades at $38 per trade.
I buy a $40 put for $3.00 per contract and sell a $40 call for $.60. Can you take me through how the maximum loss is arrived at. I am trying to minimize my loss.

Answer 1

It'll all depend on where you think the stock'll go to.

As you laid it out, your max loss on the put is 3.00/contract. Your max loss on selling the call is infinite.

If you think the stock'll stay below $40, but not go below $37, then selling the call might make sense. If you think the stock'll drop below $37, then buying the put might make sense.

BUT, before you enter into either trade, you MUST calculate your reward/risk ratio. Where will the price go if the stock reaches your desired target and where will the stock go if things go wrong? Always want an adequate reward/risk, to compensate you for the risk you are undertaking!

Hope that helps!

Answer 2

If you are trying to minimize your potential loss but wish to play the possibility that stock might either go up or go down by a large amount then you want to buy an out of the money call and an out of the money put. Not too far out of the money. Your potential loss is the cost of the put and call if the stock does not move out of the range exercise. Beyone that range you stand to make some money depending on the amount of the move.

By selling either a naked put or call your potential loss can be great if the stock moves significantly. In most cases the stock does not move significantly, but it would probably be your luck that it would.

However, covered call writers make a nice piece of change, about 10% annually.

Answer 3

Theoretically, there is an infinite maximum loss potential for you. Let's say your stock price is $200 at expiration, your per share loss on the position, ignoring commissions, is $3 per share on the put + $160 per share on the call - $0.60 per share premium on the call = ($162.40). This loss increases dollar for dollar as the stock price at expiration goes up. In this play, you are effectively creating a short position in the stock.