To:rydad
From: PAL Thursday, Aug 9, 2001 1:54 PM
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Rydad: thanks for the article on straddle and strangle. at a glance it seems complicated, but it is not. I feel that at the current market environment covered strangle can be profitable.
I have been in qualcomm since way way back. The stock seems to work in a trading range. A few years back it traded between 40 and 60 (pre 2 for 1 and 4 for 1 split). you can just go in and out: sell in the 50's and buy back in the 40's and repeat the process.
I leave it to the technical experts about cdma and the like. I only anticipate that the world will go cdma. look at asia and forget about europe. qcom is concentrating on china and her neighboring countries (sans Thailand which is another story). world cup in south korea and olympics in china will enhance cdma chances. europe is too stodgy to admit superior technology, that's why the entire continent lacks behind aggresive asian countries. look at how weak euro is. that is why qcom is the stock I concentrate. In addition I know the top management of qcom way back before qualcomm (linkabit).
In this type of sideways movement I prefer to have 50% in good stock and 50% cash (edamo prefers 100% cash and uses that to generate more cash via selling puts. He is very successful in that). The question is that I can go on vacation and forget about it: let the stock be there months from now riding the waves up and down and let the cash earns money market interest. On the other hand I want to earn extra cash and have decent return (not a windfall return).
The idea is that greed should be completely thrown out of the window. three to four percent return per month should make me happy. if I am short on option, I have to make sure that: 1) have the security in case of a call and 2) as edamo always correctly preaches: have the capacity in case of assignment of a put. (I like to call it a "covered put" but that term has been taken to mean "a short put covered by a short in the underlying security" ).
There are not many cases where long on a strangle is profitable or worth the risk because of the wide range to make it ahead of the game. that is why people do not buy strangle. should not the opposite true? the example I am going to show might make a person to reconsider. why are not many people doing that? I think because they think it is too complicated, which actually is very simple and straight forward.
The covered short on strangle is utilizing the assets, both securities and cash to generate more return. this is different from bull spread or diagonal spread which is purely for option traders. if a dummy like me can understand it, anybody can. there is need to be an expert in TA or stochastic behavior etc.
the main ingredient is that you have a great stock which you don't mind increasing your holdings providing you get it at a good price. Again, the stock is qualcomm which I expect to move within a trading range of between 55 and 75 in the next 5 months. Based on street observation, you can hope that the probability of that happening is around 95%. don't take me to task of the mean and standard deviation to get a confidence level.
Let us start using a simple example (you can do it a multiple thereof):
DO NOT USE MARGIN
owns 100 shares of qcom currently at 65
have $ 4,700 in cash.
Five months from now:
a) do nothing: have 100 shares of qcom (95 % probabiltity between 55 and 75) and $ 4,800 cash (assuming $ 100 in interest)
b) "covered" short on a strangle: sell Jan02/75 call and sell Jan02/65 put.
The call is covered by 100 shares if qcom goes above 75.
The put is "almost covered" by $ 4,800 in cash if assigned. You can get $ 1,800 premium for that strangle ($ 8 for the call and $ 10 for the put). The premium and the cash if enough to pay if assigned.
- if qcom is between 65 and 75 five months from now, you keep $ 1,800. you still have 100 shares of qcom, but you cash is now $ 6,600 versus $ 4,800.
- if qcom > 75 your stock is called away and you have $ 7,500 + $ 6,600 = $ 14,100.
- if qcom < 65 you have 200 shares of qcom plus $ 100.
The risk is: qcom < 47 or qcom > 93 (the latter is opportunity cost).
if taxes is a consideration, then do the covered call on the tax deferred account.
hope that helps.
ps as for other stocks, i have not found a more compeling reason that qcom, so that I am sticking with what I am comfortable with.
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