NLY and other HiDiv have very cheap Leaps for CalSprds

Discussion in 'Options' started by darp, Jul 14, 2011.

  1. darp



    Today with NLY at 18.05 put on a trade with Jan 2013 long 17.5C for .95 and short Aug11 18C for .35.

    So .40 time premium on 16 month option, and .30 time preminum on 1 month option ???!!!

    That is why put it on. There is great expertise on this board, can you help me understand why this and some other high div stocks have very cheap CALL LEAPS? The Puts are not as cheap.

    My theory is that because of the high div, the normal premium is reduced by the div amount to keep the Call in line with owning the stock, and on 15 month that is a lot of dividends that are removed from the LEAP Call, but 1 month out less so.

    Thus seems to make using LEAPS with Cal sprds a way to capture the divs without owning the stock, reducing risk and multiplying yield. Am I crazy?
  2. Maverick74


    You do know that you are losing the dividend right? About 2.70 worth of divies. That's a lot to give up.
  3. darp


    Hi Maverick,
    "You do know that you are losing the dividend right? About 2.70 worth of divies. That's a lot to give up."

    Yes on giving up the dividends, officially.

    But at same time reducing cost from 18.05 to .95 to "cover" the 18 short calls being sold, and just paying just .40 in time preminum for 16 months, or .03 decay a month, to get .30 decay per month.

    So lets say the perfect outcome, it sits at 18 for 16 months, that would be a $4.80 decay gained for .40 decay lost so a $4.40 profit or $440 dollar wise profit on $60 investment, or 600%+ profit.

    If I bot the stock it would be a $480 profit on $1,805 investment + the divs of $270 or $750 total, so about a 40% profit on investmnet under same circumstances.

    The profit on Puts on same stock not nearly as good under same outcome of stock price. In effect the high div does not provide the edge for lower Put price, only edge on Call.

    If its perfect for 10 months, then NLY crashes to $5. Then using the Leap. Then a $370 profit then a $95 loss or still $285 total gain on $60 investmnet.

    If stock then its -$1,305 loss and $370 gain and $180 div or -755 loss.

    Maverick I do guess that the div is taken out of the Call premium otherwise folks would buy high div stocks and sell calls against them and really get a big yield.

    But it seems interestingly that you end up capturing that div in a round about way with far less risk and higher yield with the above scenario.

    Any explanations of how the div affects the Leap Call pricing and whether this strategy makes sense or is known of, will be appreciated.

  4. spindr0


    You're not "capturing" the div. If right on direction and timing, for all stocks, diagonal spreads reduce risk and multiply yield - not just high div stocks.

    If you look at the dividend adjusted IV of the call, it's no bargain (it will be in line with the closer month options).

    Call LEAPS on high div stocks are cheap because of the dividend. Every 3 months, NLY will be 50+ cts lower and that means the LEAP strike keeps getting further and further away. NLY is a low beta/low IV stock. If a doctor gave it an EKG, he'd pronounce it "almost dead".
  5. spindr0


    In the perfect outcome, every option position makes its maximum profit and everyone on ET gets rich. But in the real world, it usualy doesn't work out that way.

    If NLY "sits" for 18 months, it's going to drop 50 cts every 3 months and that would make the $18 strike further and further away. With each div, that strike becomes increasingly worthless. After 1 ex-div, you might get 5-10 cts for writing that call.

    6 months from now (2 divs), NLY is 17. The 1 month 18c will be worthless, the 17-1/2 will be 5-10 cts and the 17c will be 40 cts. If you chase the 40 cts, you'll be doing a bearish diagonal (short strike lower than your long strike) and if NLY reverses, you lose on the spread. 600+% profit? Methinks not :)
  6. darp


    Hi Spin,

    NLY has not been declining .50 a Q, in Aug if 2010 it was 17.50 in aug of 2009 it was 16.50, its very steady, but yes if it dropped to 15 the 18 calls would be maybe .03. But then would sell half as many 16 calls as the 17.5 Leaps.

    Am happy with noticing how much cheaper the Call Leaps are than Put Leaps ATM on hi div stocks, looks like an edge.

  7. spindr0


  8. I like buying puts on these types of stocks/etfs w high divs ...

    If the market cracks again they offer cheap protection... look at PFF which hit 13$ ... you can buy Oct or Jan puts and make a killing if the market really tanks gain... sure the probability is low but the reward potential...