July 30th, 2008 by Kenric
I’ve been messing around with paper trading at Think or Swim for the past few months. I read an article about using Stock Collars with LEAPs and the ability to find trades that have 0% chance of losing money. It is really possible? I think it is when you use long term options. The pricing has to be right in order for this to work.
Here is a paper trade that I made last month (commissions not included).
I purchased 100 shares of Google at $550.76 for $55,076.
I Bought Jan 10 PUT 550 at $90.90 for $9,090 (gives me right to sell 100 shares of GOOG at 550)
I Sold Jan 10 Call 580 at $105.00 for $10,500 (gives someone right to buy my 100 shares of GOOG at 580)
I spent ($55,076 + $9,090 - $10,500) $53,666 on 100 shares of Google. This gives me a net purchase price of $536.66 a share.
What I really did here is that I paid $9,090 for the ability to sell the Google shares that I just bought at basically the same price I just paid. I can only lose $0.76 a share on my stock purchase. However, I paid $9,090 for this insurance. To offset the price of this insurance, I sold a Jan 10 580 Call which gives someone else the right to buy my shares of Google at $580. They paid me $10,500 for that right.
The $10,500 offsets the $9,090 and actually adds $1,410 into my pocket. This $1,420 lowers my Google share cost from $550.76 a share to $536.76.
So look at my trade now. I paid $536.76 for 100 shares of Google. I have the right to sell my shares at $550 up until January 2010. Someone else has the right to buy my shares at $580 up until January 2010.
I cannot lose money on this trade. Once January 2010 comes along I either sell at $550, $580 or somewhere in between.
Today
Today Google is at $477.12. The stock has dropped $73 a share from where I bought it.
How is my trade doing?
Google stock = $47,712 Net change -$7,364
Jan 10 550 PUT = $11,805 Net change +$2,715
Jan 10 580 CALL = $4,905 Net change +$5,595
I am up $946. However, with these collars its best to hang onto them until expiration. These trades are made to go almost all the way.
January 2010
What happens if Google goes below $550 on Jan 2010?
I exercise my Google 550 put and sell my shares at $550. The Jan 10 580 Call is worthless and expires. My profit is $55,000 - $53,676 = $1,344.
What happens if Google goes above $580 on Jan 2010?
The person who bought my Jan 10 580 Call exercises it and I sell them my shares at $580. My Jan 10 550 Put is worthless. My profit is $58,000 - $53,676 = $4,324. Note, this is also the maximum amount that I can make on this trade.
What happens if Google is inbetween $550 and $580 on Jan 2010?
The put and call are both worthless. I have 100 shares of Google at a price above $550 so my profit is at least $1,344 and less than $4,324.
Why don’t we all do it?
Wow, a trade where you can’t lose money. Why doesn’t everyone do this? Well because the return sucks. I am spending $53,676 for the chance to make between $1,344 and $4,324. That is a return of 2.5%-8.0% in a period of 18 months. You can get a safer return in a CD.
Of course, you can find certain put and call combinations that will increase your returns. You can use shorter term options to minimize your potential loss. Aren’t options fun?
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