Long or Short Stock Strategies

LongorShortStockStrategies

Atradermaybelongorshortstockbasedonlongtermvaluations,butstillwanttoeithertakeadvantageoforbeprotectedfromshorttermhappenings。

Wewillgooversomestrategiesbasedonthescenarioofbeinglongorshortstock。

ProtectiveOptionPurchase

Ifyouarelongorshortstockandfearamajorevent/move,youcansimplybuyputsorcallsrespectivelyinproportiontothestockyouarelongorshortandbeprotected。

Forthelifeoftheoption,thisessentiallyturnsthepositionintoasyntheticcallorput。

longstock+longput=syntheticlongcall

shortstock+longcall=syntheticlongput

Ifyouarelongstockandbuyanout-of-the-moneyput,thenifstockgoesuporstaysstillyoumakemoneyonyourstockandhavelostthepriceoftheput,whichwillexpireworthless。

Ifstockgoesdownthroughtheputstrike,thenyourstockwillhavebeencalledaway(asthatnowin-the-moneyputwillbeexercised)andyourmaximumlossisthepriceoftheputpluswhatyouhavelostonthestockgoingdownuntilthatstrike?

Aprotectiveputisalsoreferredtoasamarriedput。

GraphfromOptionVolatilityandPricingbySheldonNatenburg,p。

260。

Onemightbuyaprotectiveoptionifthereisamajorbifurcatingeventupcomingwheretheunderlyingmightmovedrasticallyineitherdirection。

Orifimpliedvolatilityistradingincrediblylowandyouperceivetheputsorcallstobeaverygooddealasaninsurancepolicysincethestocktendshistoricallytobemorevolatile。

Unfortunately,beforemajorbifurcatingeventsimpliedvolatilitiestendtotradehigh。

Whichcallorputtobuydependsonhowmuchpainyouarewillingtotakeifstockmovesagainstyou。

Thefurtheroutofthemoney,thecheaperthecallorputwillbe,butthemoremoneyyouwillloseonyourstockpositionbeforeyouareprotected。

Aneartermcallorputwillbecheaper,butyourprotectionlastsonlyuntilitexpires。

Theseoptionsareinsurancepoliciesandthebettertheinsurancethemoreyouhavetopayforit。

CoveredWrites

Coveredwritesallowthetradertogeneratecashandprotectagainstsmallcontrarymoves。

Essentiallyitisastrategyyoumightuseifyouthinkthatanunderlyingthatyouarelongorshortmightmoveonlyslightlyintheneartermorifyouarenearingapointwhereyou’vemadesomegainsandwerethinkingofsellingtocloseorbuyingbackatacertainpricepoint。

Wewillgothroughtheexampleofacoveredcall,butthemirrorimagewouldapplytothecoveredput。

Ifwearelongastock,butfeelweareenteringatimeperiodwhenitmightsitstilltemporarily,wecangenerateincomebysellingupsidecallsinproportiontothestockwearelong(1callforevery100shares)。

OurgraphofPLuntilthatcall’sexpirationwilllooklikethatofashortput。

Longunderlying+shortcall=syntheticshortput

GraphfromOptionVolatilityandPricingbySheldonNatenburg,p。

262。

Ifstockmovesdown,weareprotecteduptothepriceofthecall,ifstockmovesupbutnotthroughthestrikeorstaysstill,thenwewillreceivethedecayonthecallwhichwillexpireworthless。

Ifstockblowsthroughthestrikethenthecallweareshortwillbeexercisedandourstockwillbecalledaway。

Ourprofitwillbethepremiumwereceivedontheoptionsale。

Sothisstrategyisverydifferentfromaprotectiveoption。

Weareonlyprotectedontheshortsidebythepriceofthecallandourupsideprofitbecomeslimited。

Youhavetobewillingtosellyourstockatthatstrikepriceifitgoestherebeforeyourcall’sexpiration。

That’swhythiscanbeanicestrategyifyouhaveseensomegainsandareapproachingalevelwhereyoumightsellyourstockanyway。

Forexample,stockcouldbereachingwhatyouseeasaresistancepoint。

Youcansellacallatthatresistancepointstrike。

Ifitgetsclosebutnotthroughyouhavemadethepriceofthecallandarestilllongthestockifittriesagain。

Ifyoudohavetosellyourstock,itisapointwhereyouwerewillingtosellanyway。

Duringthelifetimeofthecall,onecanlosemoneyiftheimpliedvolatilitygoesupandyoudecideyouwanttobuyitbackbeforeexpiration。

Thiscouldhappeniftherewerenewsthatwasperceivedaspositiveandyoudecidedyouweren’twillingtosellstockatthatprice。

Thenyouwouldhavetobuybackthecallforwhatmightbemorethanyoureceivedforit。

Whichcalltoselldependsonwhatyouthinkthestockwilldoandwhereyouarewillingtosellit。

Obviously,theclosertoat-the-moneythehigherthepremiumandsothemoredownsideprotectionyouwillhavebutyouwillnotbeabletopartakeinanyupsideprofit。

Thefartherout-of-the-moneytheoptionisthelessyouwillreceiveforsellingit。

Thecoveredcallisastrategywewouldprimarilyrecommendforneartermoptionsasthedecay,theta,isgreatest。

Ifthebuyingofthestockandsellingofthecallisdoneatthesametimeitisreferredtoasabuy/write。

ShortPut

Sayyouwanttobuystockifitgoesdowntoacertainprice。

Youcouldputoutalimitorder,butanotherwaytodothiswouldbetoshortaputatthestrikewhereyouwanttobuythestock。

Ifthestockgoesdowntoyourstrikeyouwillbeassignedontheputandwillbuystock,plushavingreceivedthepremiumforthesaleoftheput。

Ifstockdoesn’tgodownthroughthatstrikeorgoesup,thentheputwillexpireworthlessandyouwillhaveprofitedbythepriceoftheput。

Thisisnotaprotectivestrategy。

Itissimplyawaytogeneratealittleincomeifyouwereplanningonbuyingstockatacertainpricepointanyway。

Againthedangerisifnewscomesoutthatmakesyouchangeyouropiniononbuyingstockandimpliedvolatilitygoesupsothatyouhavetobuybacktheputformorethanyoureceivedforit。

Collar

Acollar,alsoknownasafence,isthecombinationofaprotectiveoptionandacoveredwrite。

Youhavelimitedbothyourprofitandyourloss。

Longstockcollar。

GraphfromOptionVolatilityandPricingbySheldonNatenburg,p。

264。

Shortstockcollar。

GraphfromOptionVolatilityandPricingbySheldonNatenburg,p。

265。

Fromthelongstockperspective,forevery100sharesofstockyouarelong,youwouldbuyoneputandsellonecall?

Thisisanicestrategyifyouarenervousaboutabigmovedown,butdon’twanttopayalotfortheprotectionandarewillingtolosesomeupsideprofitpotential。

Againifyou’veseensomenicegainsalreadyinastockandareapproachinganearningsthatyouthinkmightbequestionablethiscanbeagoodstrategy。

DanrecommendedcollarsasawaytoprotectalongpositiongoingintoApple(AAPL)earningsonJanuary20,2012。

Hisreasoningwasthatthestockhadgoneupinrecentmonths,andalthoughthefundamentalswerestrongandsentimentpositivethattherewasreasontobequestionableabouttheseearningsandconferencecallwithanewCEO。

TherewasprecedentwithabigdownmoveinGoogle(GOOG)onJanuary19thwhen,despitegenerallygoodsentimentleadinguptoit,earningssentthestockdownover8%?

Inthiscase,afterearningsonJanuary25,2012stockwentupjustbeyondtheupsidecallthatherecommendedshortingwiththecollar?

But,withthreeweekstoexpirationtherewasstilltimeforforthatcalltodecayandimpliedvoltocomeinaftertheeventofearningsandbeboughtbackforlesspremiumifthetraderdoesn’twanttobecalledinonthestock?

SeeDan’supdatehere?

That’swhythinkingabouttheGreeksandhowtheyaffectoptionpricesovertimeisimportantfortrademanagementaseventsandexpirationoftendon’tcoincide。

Thecollarisaniceconservativestrategyifyouthinkstockisgoingupgenerally,butareanxiousaboutabigmovedownonanevent。

Thesamethingcanbedonewithashortposition,buyingacallandsellingaput。

Thecollarcanbeputonforacredit,debitoreven。

Againwhichoptionstochoosedependonhowmuchdownsideyoucantakeifstockgoesagainstyouandhowmuchupsideyouarewillingtoloseifstockgoesthewayyouarelongorshort?

Itisimportanttoconsidertheseactualscenariosratherthanjustthepriceofthecollar。

Puttingonacollarforcreditcanbeverytempting,butyoumaynotbecompletelysatisfiedwiththeconsequences。


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