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


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To: PAL who wrote (6)8/19/2001 12:38:16 PM
From: PAL
   of 23
 
What if QCOM did not close at 61.56 on 8/17/01?

Covered Strangle : owns 1000 sh of qcom and cash $ 57,650
100%/short puts : cash $ 121,400

The breakeven is ($ 121,400 - $ 57,650)/1000 shares = 63 3/4.

Therefore, if QCOM closed higher than 63 3/4 Covered strangle is better.

If QCOM closed between 60 and 63 3/4 , then 100% cash/short put is better.

The next question is, what if QCOM closed below 60 and you get a call on Monday that you have been assigned?

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To: PAL who wrote (7)8/19/2001 1:13:10 PM
From: PAL
   of 23
 
What if the stock closed below 60?
We will get assignment on Monday at a price of 60.

Covered strangle: we have $ 57,650 cash and already own 1,000 shr of qcom.
Net result:
own 2,000 qcom MINUS $ 2,350

100% cash/short put: we have $ 121,400 cash.
Net result:
own 2,000 qcom PLUS $ 1,400

The latter is better.

Conclusion:

If qcom had closed below 63 3/4 last Friday 100% cash/short put is better, but if it closed above 63 3/4, then covered strangle is better.
own

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To: PAL who wrote (8)8/19/2001 6:29:36 PM
From: PAL
   of 23
 
We know reach the point where we need to calculate the risk associated with each strategy.

The starting point is $ 110,000 to start with. Opportunity cost is not factored in; as edamo wrote: you cannot spend opportunity. Therefore, we should look at the size of the holdings at the end of 8/17/01 and what it would be were the stock closed at a different level.

a. for 100% cash/short put, the breakeven level can be easily calculated: Premium = 5.70, and strike price $ 60. Then the breakeven level is 60 minus 5.70 = $ 54.30.

b. covered strangle:
you have 1,000 shares of qcom, and the ctock falls below 60, then you are assigned 1,000 shares of qcom. The covered call option becomes worthless, so you keep the premium. Totdal cash before assignment is 57,650. After assignment at $ 60/share, you will have

2,000 shares of qcom MINUS $ 2,350. Where is the breakeven level?

2000 x - 2,350 = 110,000
2000 x = 112350

x = 56.175

Therefore, the risk level is lower for 100% cash/short put as summarized below:

a. covered strangle: qcom should close above 56.175

b. 100% cash/short put : qcom should close above 54.30

(Remember previous post: 100% cash/short put is preferred over covered strangle if qcom closed below 63 3/4, but keeping all cash and do nothing is the best if qcom closed below 54.30)

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To: PAL who wrote (9)8/20/2001 1:44:05 AM
From: PAL
   of 23
 
What the the maximum return for Covered Strangle and 100% cash/short puts?

a. 100% cash/short put: the maximum return is to keep the premium, i.e. 20 times $ 5.70 times 100 = $ 11,400 or = 10.36%. this happens when the stock closes above 60.

b. the maximum return for covered strangle is when the stock is above 65:
- 1,000 shares of qcom is called at 65 = $ 65,000
- cash = $ 57,650
- premium kept = $ 9,700
_________

Total $ 132,350 or appreciation of 20.31%

__________________________________________________________

Summary:

Covered strangle:

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

100% cash/short put:

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

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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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