Options Question?

Question

I think a stock is (maybe) due for a nice rebound and I want to own some shares. The stock is selling now for $27. I sell a put one month out at $25, and buy a couple of calls two months out at $30. If the price goes down, I'll have 100 shares put to me at a bargain price. If the price goes above $30, I can buy shares at below market value at time of exercise and keep the put $. Does this option combination have a name? And is it a sensible strategy assuming I'm bullish? I'm an options novice, so I would appreciate any serious replies.

Answer 1

(1) I have never heard of a name for that combination.

(2) If assigned on the short put the effective price you are paying for the stock might not be much of a bargain. For example, if the put is trading at $1.00 and the calls are trading at $1.50. That would make your cost for opening the trade ((2 x 150) - 100) = $200. If the stock goes down and you are assigned your effective cost would be ($2,500 + $200) = $2,700, the same price as the current price for 100 shares.

(3) The strategy makes some sense because you are bullish and both the short put and the long calls are bullish positions. It is not at all clear, however, why this strategy would be superior to simply buying the stock.

(4) If you don't know enough about options to explain why you think it is superior to simply buying the stock, I would recommend just buying the stock instead.

(5) I believe "richard t" is incorrect in thinking you want a straddle since that is a combination of a bullish position and a bearish position.

(6) I have no idea why "chiky" thinks you did not understand that you would have to buy the stock for $25 per share if the the short put is assigned. I thought you did understand that but if you did not it is good that she mentioned it.

Answer 2

First thing to remember is a mistake in your example here. By selling the put, you are obligated to buy the shares at $25. VERY common oversight and easy to forget. So, if the price goes down, below the $25/share, sure it's a "bargain" in the sense that you may have been willing at one point to buy it at a higher price; however, if it is below $25, why would you want to buy it at that point, when you could buy it at market price for less. This leaves out any premium you got for selling the put, which essentially lowers your breakeven point, but the principle is the same. And if you're just starting out, it's good practice to ask questions and think about these things.

It's not a bad strategy per se, but sellers of options contracts generally want the contracts to expire worthless, so they get to keep the premium they received and have no obligation. Buyers of options are limited in losses to whatever premium they paid. For what it's worth, selling calls is, in theory, unlimited in loss potential, and selling a put is only limited by how far the stock price is from $0. Remember, you have to buy at strike price, regardless of current market price. So if it goes to $0/share, you've paid for something at whatever price, and has no resale value.

good luck.

Answer 3

options drop in value very quickly............time value........
you need to see what the cost of your transactions will be.
I believe what you want to do is a straddle...........pick up a book before you jump in.....it is cheaper that loosing on a bad trade........