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   Strategies & Market TrendsA Study of Covered Strangle in a Rather Neutral Market


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To: PAL who wrote (10)8/20/2001 2:05:43 AM
From: PAL
   of 23
 
Now we have to comapre covered strangle against buy/write strategy.

Under buy/write strategy: start with 110,000

On 7/18/01 bought 1,800 shares of QCOM at 62.25. Thus holdings:

1,800 shares of qcom and $ 2,050 in margin account.

on 8/2/01 (at the high) sold 18 calls at 4.20, and collected
$ 7,560

Now we have 1,800 sh of qcom plus $ 5,510 in cash.

On Friday, qcom closed at $ 61.56. (continued in next post)

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To: PAL who wrote (11)8/20/2001 2:31:08 AM
From: PAL
   of 23
 
The value of the holding on 8/17/01

Owns 1,800 shares of qcom plus $ 5,510 in cash:

1,800 times $ 61.56 = 110,808 + 5,510 = 116,318, giving a gain of 6,318 or 5.7%

At what level will buy/write start incurring a loss?

We started out with 110,000. Let "X" be that price of qcom:

1,800 X + 5,510 = 110,000 or 1,800 X = 104,490

then X = 58.05.

________________________________________________________

Now we can compare the risk level (that is at what level will the loss start) for each strategy:

100% cash/short put : 54.30
Covered strangle : 56.175
Buy/write : 58.05

Therefore, 100% cash/short put has a lower level of tolerance in a down market.

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To: PAL who wrote (8)8/20/2001 2:58:10 AM
From: PAL
   of 23
 
Remember that the three scenarios produce the following portoflios:

a. 100% cash/short put : 2,000 qcom + 1,400

b. covered strangle : 2,000 qcom - 2,350

c. buy/write : 1,800 qcom + 5,510

in a down market a) is definitely better than b) because you have the same number of shares but b) has a margin debit balance.

If the market really is under severe pressure, then a) and b) will suffer greater losses than c) since they have more shares.

At what point will the portfolio holdings of a) and b) be smaller than c)?

a) vs c)

2000 X + 1,400 = 1,800 X + 5,510
200 X = 4,110
x = 20.55

b) vs c)

2000 x - 2,350 = 1,880 X + 5,510
200 x = 7,860
x = 39.3

Therefore, the lines of a) and c) intersect at 20.55 and the lines of b) and c) intersect at 39.3

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To: PAL who wrote (13)8/20/2001 3:14:58 AM
From: PAL
   of 23
 
Under buy/write the maxim return will be achieved when the stock closed at 65 or higher. The holding will then be all cash:

1,800 times 65 = $ 117,000
cash = $ 5,510
_________

Total $ 122,510 or a gain of $12,510 on the original $ 110,000 which translates to 11.37%.

________________________________________________________

Summary

100% cash/short put:

Maximum return: stock at least 60, profit of 10.36% versus risk when stock closed at 54.30.

Buy/write:

Maximum return: stock at least 65, profit of 11.37% versus risk when stock closed at 58.05

Covered strangle:

Maximum return: stock at least 65, profit of 20.31% versus risk when stock closed at 56.175

(see posts # 10 and # 12)

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To: PAL who wrote (14)8/20/2001 3:25:00 AM
From: PAL
   of 23
 
Since the options expired worthless, there is no open position. There is a temptation to immediately open a new position. But I think we do not have to be in the market all the time. Therefore, I am willing to wait until such time to sell puts/and or calls.

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To: PAL who wrote (14)8/20/2001 11:14:38 AM
From: PAL
   of 23
 
On the one end of the spectrum we have $ 110,000 cash and keep it that way. The risk is practically zero in money market account and the maximum return is the interest earned.

On the other end of the spectrum is buy and hold:
Based on a price of $ 62.25, you have 1,767 shares of Qualcomm and a few dollars change. The risk is if qcom falls below 62.25, and the maximum profit is unlimited.

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To: PAL who wrote (16)8/20/2001 6:12:49 PM
From: PAL
   of 23
 
Memo to the diary: August 20, 2001 after the close:

Dow 10,320.07 +79.29 +0.8%
Nasdaq 1,881.35 +14.34 +0.8%
S&P 500 1,171.41 +9.44 +0.8%
QCOM closed at 63.71 +2.15 or 3.49%


Based on last Friday's close, the five strategies stood as follows (including the value of the holding as of 8/17/01):

a. 100% cash : $ 110,000 value: $ 110,000

b. 100% cash/short put : $ 121,400 value: $ 121,400
see post # 6 :
Message 16231120

c. covered strangle : 1,000 sh of qcom plus $ 57,650
value $ 119,210
see post #5:
Message 16229088

d. buy/write : 1,800 sh of qcom plus $ 5,510
value $ 116,318
see post #11
Message 16233058

e. buy and hold : 1,767 sh of qcom plus $ 4.25
value $ 108,781
see post #16
Message 16234140

Did not do anything today on QCOM: it is not near the low (to sell puts) nor the high (to sell calls) of the trading range.

I will so a covered strangle again whenever the environment is favorable. This will be an actual trade. I will then compare with other strategies.

When I do the actual sell on the calls, I will also enter a similar "pseudo trade" on buy/write, and conversely, when I make a real trade of selling puts, I will do a "pseudo trade" for 100% cash/short put. The appropriate "pseudo trades" will also be performed if the actual shares are sold/bought.

Until the next real trade.

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To: PAL who wrote (17)8/21/2001 7:10:38 PM
From: PAL
   of 23
 
Augus 21, 2001 after the close:

The Fed cut fed funds rate to 3.5%, the lowest level since Spring 1994, and the discount rate to 3%. Many expected that the market would rally, but ...

Dow 10,174.14 -145.93 -1.4%
Nasdaq 1,831.30 -50.05 -2.7%
S&P 500 1,157.26 -14.15 -1.2%
QCOM 62.44 -1.27 -1.99%


did not do anything, the market is still moving sideways: down on Fraiday, up on Monday, down today.

Current holding is still:

1,000 sh of qcom plus $ 57,650

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To: PAL who wrote (18)8/22/2001 11:06:11 PM
From: PAL
   of 23
 
August 22, 2001 after the close.

Dow 10,276.90 +102.76 +1.0%
Nasdaq 1,860.01 +28.71 +1.6%
S&P 500 1,165.31 +8.05 +0.7%
QCOM 63.75 +1.31 +2.10%


Bounching back again. Still in the middle of the trading range.

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To: PAL who wrote (19)8/23/2001 7:37:23 PM
From: PAL
   of 23
 
August 23, 2001 after the close.

Dow 10,229.15 -47.75 -0.5%
Nasdaq 1,842.97 -17.04 -0.9%
S&P 500 1,162.09 -3.22 -0.3%
QCOM 62.95 -0.80 -1.25%


The stock was strong in the morning reaching to a day high of 65.85, but then retreated.

Make sure to think twice if I want to sell options expiring in September since it is a triple witching month: it is known for heavy trading volumes and increased market volatility (especially about 30 to 60 minutes before the close).

Also remember that dollar for dollar you get more money buying longer term option. For example you could purchase jan02/60 (expiring in 5 months) put on qcom for $ 800/contract. By the same comparison, you could purchase apr02/60 (expiring in 8 months) put on qcom for $ 1,000/contract. An additional $ 200 for 3 more months means more bang for your buck.

Calculate it differently:

jan02/60: $ 160/month
apr02/60: $ 125/month

Option is a time-decay asset, they decay or lose value as they approach expiration. A large part of the decay comes in the final month before expiration (some call it front month). Buying option that expire in more than six months gets you pass this "decay curve".

If you I am a seller of an option, make sure that I remember the above.

Option trade in nickel increments below $ 3 and dime increments above $ 3. The problem with option is that in addition to the large spread between bid and ask (around 8%), the commission is considerable more than that for equity trade.

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