How crazy is this?

Discussion in 'Options' started by Eliot Hosewater, Jul 8, 2006.

  1. I did a put credit spread on a stock last month. I sold the long leg just before expiration and allowed the short put to be exercised. My cost basis for the stock was 33.10. I don't mind owning the stock as it pays a good dividend.

    I was thinking of selling a "strangle" where both legs are in the money. I could sell another 35 put, as well as a 30 covered call for 7.20. If the PPS stays in the 30-35 range both options would be exercised. The stock PPS is currently about 32.50.

    Here's how I figure the numbers:


    $35 - original short put
    $35 - new put
    $70 - total cost


    $1.0 - original spread
    $0.7 - selling original long put
    $30 - from having CC exercised
    $7.20 - selling new strangle

    So if both legs are exercised I would wind up with the same number of shares that I have now, for 31.10/share (70.00-38.90). There's a chance my current shares would be called early since there is a 1.40 divvy due before expiration (I'm thinking of doing the Aug exp.). There is another 1.40 divvy due after the Aug expiration, which may or may not also include a special of up to 2.00. Even if I miss out on the first dividend I would still be .60 ahead (33.10-1.40=31.70 vs 31.10).

    I figure the worst case is the PPS drops below 27.80.

    Is this totally whacked? I've never heard of doing this before. Am I missing something?
  2. Let's see if I can work out what you're doing.
    You have been assigned on a short put and are now long the stock.
    You want to sell the strangle.
    End result - long stock, short put, short call.
    You in essence end up with a short put plus a synthetic short put (long stock with short call=covered call=synth short put).
    Summary - you have 2 short put positions, albeit one is synthetic. Very bullish indeed and, of course, large risk - but then you say you don't mind owning the stock.
    Unfortunately you aren't very clear on your numbers so I can't analyse your position any further. All I can say is that if you got an initial spread cr of $1 and then you sold your long leg for $0.7 then your total credit was $1.70 which makes your stock cost basis $33.30 (not $33.10). I don't know what other mistakes you've made in your calculations but it seems you've counted your initial credit twice (once in you cost basis calculation and then again in your "income" section). Overall this is a bullish strategy and if the stock goes down you lose money.
    Rationale for this strategy?
    daddy's boy
  3. Quote "Cost

    $35 - original short put
    $35 - new put
    $70 - total cost"
    I think you've added up the strikes to give you a cost???!!! I think your calculations are all screwed up, unfortunately - you've confused strike prices with premiums and vice versa.

    Anyway, I've plotted a risk graph of your position based on some assumptions. I'm assuming you paid $33.10 for the stock and have taken in a credit of $7.20 for the new strangle and the credit from the original trade of $1.70 ($1 + $0.70). The result is a trade with a potential max profit of $580 and max risk of $5918 - roughly a 10% return.
    If stock is below $29.60 (break even) by expiry, you lose money. If stock is at $27.80 at expiry, your loss will be about $360.
    daddy's boy
  4. Thanks for taking the time to look at this.

    The 35+35 mean that I paid 35 for the stock from having the original put assigned, and I'm assuming the new short put at 35 would also be assigned.

    The rationale for doing this would be to own the same number of shares that I do now, but at a cost of 31.10 instead of 33.10.

    If the stock falls below 30 I would own twice as many shares but the new ones would cost 27.80. Still not bad considering the divvy.
  5. Sorry, the cost for the original stock should have been 33.30 (35.00 - 1.00 - .70).

    I made a typo at first and kept repeating it. That's one reason I posted this, to have other people look at it. I have a degree in math, never could do arithmetic.
  6. OK, thanks to MoMoney on the Position Simulator thread, I now know this is called a guts strangle. I don't know why someone would take the long version of one, it seems there would be easier ways to accomplish the same thing.

    As I said earlier, my goal in shorting this was to lower my cost of the shares I want to keep anyway. If the stock stays in the 30-35 range then I got paid 7.10 to lose 5.00.