I am a brand new irregular, very much impressed by the rich content of this site, Travis’ contributions and the lively discussions in the community. This is my first post.
I consider myself a long-term investor, not a trader, who is using options to build-up stock positions and manage risk. Fifteen years ago, I was a CANSLIM swing trader, ten years ago I was trading non-directional iron condors on RUT and five years ago I thought I could consistently make profits trading risk reversals on short term VIX options. After much reflection, counterfactual analysis and programmatic backtesting, I came to the conclusion that options are priced to perfection in the short-run. In hindsight, the evidence has always been right in front of me as the only consistently profitable part of my portfolio has been my long-term buy and holds. I do not regret my long and steep learning curve, today I enjoy investing more than ever (this exceptional bull market of course helps…).
I noticed that some people have expressed interest for more discussions on option strategies, so I happily try to contribute (sporadically). Please understand that, by no means, I claim that my method of investing is better than anyone else’s. Investing with options is all about making trade-offs and bringing your choices in line with your risk tolerance. There is not, and never will be, a holy grail method of option investing (despite of what several guru’s will try to make you believe). What I explain below is nothing fancy or high-tech and people well versed in options can skip this post, there is so much else to read on this forum!
Inspired by another thread, where an interesting newsletter promising 100x returns is being tracked, I yesterday decided to open two new positions, one in $NNDM and one in $OPTT. Yesterday’s closing prices of these stocks were 14,53 and 5,02 respectively. Rather than outright buying 100 shares of each, which I will use as a benchmark below, I bought what is called the ‘synthetic’ equivalent, namely I bought one call and sold one put with the same strike and the same expiration date. To lower my debit paid, I also sold an out-of-the money (OTM) call, essentially making these positions synthetic covered calls. Here are the specifics:
Bought May21’21 strike 10 call for 6,8 debit
Sold May21’21 strike 20 call for 3,7 credit
Sold May21’21 strike 10 put for 1,85 credit
Total combo: 1,25 debit or 125$ paid
Bought May21’21 strike 5 call for 2,2 debit
Sold May21’21 strike 10 call for 1,4 credit
Sold May21’21 strike 5 put for 2,1 credit
Total combo: 1,3 credit or 130$ received
Note that, combined, these positions have hardly influenced my total available funds. Yet, for sure, I am now invested in these stocks as I will explain below. So here is a first reason why I think this method can be beneficial, at times, and for some of you: when your newsletter on a regular basis comes out with new recommendations, and you try to buy each and every new recommendation in fear of missing out, many people face difficulties financing the new recommendations and therefore, reluctantly, see themselves forced to sell parts of another winning position. By switching to options, you buy time, in this case until May 21 of this year.
Because what is going to happen on that day? If $NNDM is still under 20 and $OPTT still under 10, I will exercise (or be exercised) on my position and essentially buy 100 shares of $NNDM for 11.25$ (10$ long call strike + 1,25 debit) and 100 shares of $OPTT for 3.7$ (5$ long call strike – 1,3 credit). Note that I have fixed my purchase price yesterday, although I will own the stocks only in May. I buy these stocks at a 22,5% and 26% discount, compared to yesterday’s closing prices, respectively. This is obviously a second reason why you could consider buying a synthetic position.
Are these two reasons combined too good to be true, in other words, what is the extra risk, compared to simply buying the stock immediately? Well, the same as any covered call position really, I have put a cap on my upward profit potential (on top of the downward risk of the stock going to 0, which a buy and hold stock buyer also faces). If $NNDM closes above 20 and $OPTT closes above 10, I will (only) make 875$ (=(20-10-1,25)*100) and 630$ (=(10-5+1,3)*100) profits and not own the stock and maybe miss out on some extra profit by that time. Does that bother me? Not really, but maybe it does bother you. This is exactly the trade-off at play here, and the outcome, i.e. your choice how precisely to invest, will depend on your risk-profile and your trading psychology. I am not really concerned because I know that I will set-up a new synthetic position and eventually the stock will let me in, as no stock shoots straight to the moon. If these stocks really have 100x potential, which will take them very likely at least a decade if not more, I can afford to wait a quarter (note that I am buying and selling options 3 months out) or more now.
When owning the stock in May, it is likely that I will try to lower the purchase price further, by selling another OTM call, this time turning the position in a standard covered call. Of course also then, there will be similar risks as described above to be considered.
But, in sum, I think it is worthwhile considering this method when constructing a well-diversified portfolio of micro/small cap stocks, certainly if you often find yourself in difficulties financing them. For reasons of margin requirements, the method can only be used for lower priced stocks, but for many microcaps that is the case anyways.
I hope this post was interesting for some option enthusiasts here.
Good luck and to paraphrase Travis: thanks for reading!
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