The Weekly Strategy Discussion is designed to assist individuals in learning how
options work and in understanding various options strategies. Options involve risk and are not suitable
for all investors. The strategies discussed are for educational and illustrative purposes
only, and should not be construed as an endorsement, recommendation or solicitation to buy or
sell securities. Commissions, taxes and transaction costs are not included. Please contact a tax advisor for the tax implications involved in these strategies.
DJX LONG STRANGLE
Example:In this example, the Dow Jones Industrial AverageSM (DJIA) has seen some large swings in the past three weeks. The CBOE lists Options on the DJIA (DJX) that track the DJIA on a 1/100 basis. (i.e.: DJIA 10,000 = DJX 100). In this example, the DJX is at a level of 127.50 (DJIA=12,750).
Outlook:You believe the DJX will continue to be volatile, but are unsure of direction. You want to take a position that may profit if the DJX moves significantly up or down.
Possible
Strategy: Strangle.
Buy 1 DJX April 130 call at 1.25.
Buy 1 DJX April 125 put at 1.00.
(Net debit of 2.25 or $225.00.)
*All values shown below are at the time of expiration.
Index Change
|
DJX at exp.
|
April 130 call Value
|
April 125 put Value
|
Strangle Cost
|
Net Profit/(Loss)
|
+ 5.88%
|
135.00
|
$500.00
|
$0.00
|
($225.00)
|
$275.00
|
+ 3.73%
|
132.25**
|
$225.00
|
$0.00
|
($225.00)
|
$0.00
|
+ 1.96%
|
130.00
|
$0.00
|
$0.00
|
($225.00)
|
($225.00)
|
+/- 0.00%
|
127.50***/****
|
$0.00
|
$0.00
|
($225.00)
|
($225.00)
|
- 1.96%
|
125.00
|
$0.00
|
$0.00
|
($225.00)
|
($225.00)
|
- 3.73%
|
122.75**
|
$0.00
|
$225.00
|
($225.00)
|
$0.00
|
- 5.88%
|
120.00
|
$0.00
|
$500.00
|
($225.00)
|
$275.00
|
At Expiration (04/19/08)
Max. Gain: Unlimited on the upside; Substantial on the downside
** Break Even: At 2 points; DJX at 132.25 (+3.73%) or 122.75 (- 3.73%)
*** Unchanged: Loss of $225.00
**** Max. Loss: $225.00 if the DJX is at or between 125 and 130
In short:
You enter into a position in DJX for a $225.00 cost that can profit after a + / - 475 point move in the DJIA by expiration. Your maximum risk is limited to the initial cost of the strangle. Loss occurs when the DJIA is anywhere between 13,225 and 12,275.