Facts: 1) You have $4,200 in cash 2) QQQQ is at $42.00. 3) You are bearish on QQQQ. Your brother-in-law creates this totally risk-free method to "sell short" QQQQ: Step 1: Buy Jan 2008 QQQQ 42 put (YWZMP) at $3.70 (current offer). Cash used: $370. Step 2: Take remaining $3,830 ($4,200-$370) and buy a 2-year CD at 4.85% End of 2 years (approx): CD is now worth $4,210. If QQQQ increases (boo), your put option is worth $0, but your CD keeps your original $4,200 intact. If QQQQ decreases (yea!) your put option increases 1/1 for the drop in QQQQ and your CD returns $4,210. Isn't this the same as shorting QQQQ BUT with ZERO RISK? Any flaws to my logic? Thanks, RetiredInvestor NYC
Your premium is recovered in Step 2: Step 2: Take remaining $3,830 ($4,200-$370) and buy a 2-year CD at 4.85% End of 2 years (approx): CD is now worth $4,210. The increase in the CD returns the premium that you paid.
Then I guess it's a perfect trade/hedge nothing new it's really just a high breed spread but you are always faced with the possibility of a breakeven trade and all that lost interest.
I agree that there is no capital loss risk in this position (although commissions make it a negligible loss) but the bad side is that you could earn nothing on your money in 2 years, yet still have to pay taxes in the $370 in interest. Of course if you are truly bearish it is still a cheap two year short. However I think most traders would prefer to buy the put and put the remaining money to work elsewhere and make more than 4.85%. It is interesting though.... Might make more sense for a long-term investment in an IRA where you use the calls on the market overall and just set and forget. It is not a risk issue just an opportunity cost perhaps since by virtue of the CD you are locked into the position and cannot get out unless you take a penalty. Too restrictive. If you must do it, use treasuries and now have almost risk-free but you can get out at any time.
Yes, in other words, zero risk if the market goes against you? That sounds pretty good to me. Risk Reward Analysis: Risk: Absolutely zero Reward: Possibly very high Maybe I'm old fashioned, but what is there not to love about this strategy? I've read about the opposite trade (buy call options along with CDs) at a blog http://www.protectedstocks.com/main/2005/09/chapter_6_struc.html (last time I cited a blog, I was accused of SPAM, but this blog isn't selling anything....not even Google Ads) but I've never read about buying Puts with CDs. Hasn't someone out there had experience with this or strong opinions? Thank You.
But with most trades, like buying 100 shares of QQQQ, you run the risk of actually losing money in addition to having your money tied up for 2 years not earning interest. Right? RE: taxes Wouldn't your $370 of interest income be offset (more or less) by the taxable loss of your $370 option premium (assuming your put expired worthless)?
Well with the QQQ your money is not tied up really, you can get out at anytime. With an option and CD purchase the CD locks you in for two years. A I wrote above, maybe you can do it with treasuries and this way if you get a huge move early you can take the profits out and invest elsewhere. But if you want to just set and forget in an IRA then it seems fine. As for taxes, I believe the interest is income and the option is cap gains but not a huge net tax amount. Just an minor issue which is avoided if this is done in an IRA.
I can't believe no one caught this. You are locking in a decent loss here. And I'm not talking about commissions. You are not factoring in inflation and the value of the dollar. Historically inflation has avg about 2.5% a year but now I would say it's closer to 5% a year. So if the market goes higher and your put expires worthless, you are actually locking in a 5% loss each year. Not good at all. I would say this is far from zero risk.