2010 Jan 17 - Sun
Option Trading Scenarios
Most option trading books discuss the mechanics and mathematics of option trading. Rarely
do they offer up any sort of in-the-trenches useful guidelines for doing what when and how.
Some recent reading has enlightened me on some useful option trading scenarios.
The first one provides the dual mechanism of obtaining income and optionally
paying for protection on an underlying which is already in one's portfolio.
The process involves selling a kind of straddle: selling an out of the money call
and an out of the money put. For example, with TSL, as of Friday's close, is at $49.50.
The Feb 55 Call is at $1.75 and the Feb 48 Put is at $3.25. Selling this results in $5.00 premium.
If TSL stays within the range of $48 and $55 till Feb 19, the full premium is kept. If
the price goes above $55, the underlying will probably be exercised to result in a $5.50 profit,
which is the premium plus the amount the underlying goes to get to the strike price. If
the price goes below $48, the Put will go into the money, most likely causing it to be
exercised, and you'll end up buying the underlying at the Put strike price, which may be a
good thing if you are expecting the price to rebound. On the protection side, the premium
earned on the put and call sale could be use to purchase twice the number of puts at the next
out-of-the money price, which in this case would be Feb 45 Put.
This provides protection on the original underlying plus the
shares gained when the buyer exercised the puts.
Another strategy requires maintenance of no underlying. For a stock that you
think will go up due to some upcoming good news, such as an earnings announcement,
one could sell an out of the money put and use the funds to buy and out of the money call.
By careful selection of put and call strikes, the money gained by selling the put may
fully cover the price of buying the call. The downside of this is if the price of the
underlying goes below the put strike price. You may end up owning the underlying in this case, but
at least it was obtained at a lower price.
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