Wondering if you can help me make sense of this situation: Day 1 - Long stock @ $25 Long put @ 25 strike Day 5 - Stock drops to $23 Write call @ 23 What would this payoff diagram look like? I've tried to use thinkorswim's program, but not sure that it looks correct. What i am trying to do is minimize loss to downside by writing the call and protect against further losses by having the put in place. Does this scenario pan out? Thanks for any input, Larry
I will give it a shot. The long stock + long put combination is a synthetic equivalent to a long call. After the stock drops by $2, your synthetic long call is in the red, but that loss is capped at what you paid for the put. By then writing an ATM call, you are reducing your loss or even accruing a gain (depending on how much premium you get for the call write) if the stock goes down further, but you are increasing your potential loss if the stock then rallies. Your loss on the upside would continue increasing until the stock hits $25 again, where your synthetic long call and the short call neutralize. I've enclosed a ToS risk profile for what a trade like this in FB would look like, using the $28 current stock price for the long stock + long put combo, and about $26 for the short call write (I simulated what the approximate price might be for the call write using the current ATM call price). You can see that it ends up looking like a bear spread when you write the call.
You are synthetically long the 25-23 put spread (or alternatively synthetically short the 23-25 call spread.) Max profit at 23.
Just words of wise (and experience) - sometime it is better to do Nothing than try to repair a broken trade. Just wait and who know the stock may rally? Worst case you are fully protected by the long put, you can exercise the put at $25.
Thanks for the help all. I think i got it now: my scenario is basically a synthetic call @ 25 and a short call @ 23.