Strategies

A  A  A     

Weekly Strategy Discussion

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.

Using LEAPS® to reduce the risk of a long stock position

BULLISH

Situation:
Holding FAV (Favorite Stock) @ 74 1/4, 52-week high is 102; 52-week low is 65 5/8.

Outlook:
Bullish over the next 18 months, but looking to reduce risk over the short term.

Possible Strategy:

Collar:
Hold 100 shares FAV; buy 1 FAV Jan (01) 70 put @ 8 5/8; sell 1 Jan (01) 95 call @ 8 1/2 ($12.50 net debit).

Change
FAV at expiration
Stock P/(L)
Jan 70p P/(L)
Jan 95c P/(L)
Net Profit/(Loss)
+27.90%
95.00 *
2075
(862.5)
850
2062.5
+21.20%
90
1575
(862.5)
850
1562.5
+14.50%
85
1075
(862.5)
850
1062.5
+7.70%
80
575
(862.5)
850
562.5
+0.20%
74.375 **
12.5
(862.5)
850
0
-0-
74.25 ***
0
(862.5)
850
(12.5)
-5.70%
70.00 ****
(425)
(862.5)
850
(437.5)
-12.50%
65
(925)
(362.5)
850
(437.5)

AT EXPIRATION (1/22/01):
* Max Gain: $2062.50 @ 95 or higher (+27.9%)
** Breakeven: FAV @ 74.375 (+0.2%)
*** Unchanged: Loss of $12.50
**** Max Loss: $437.50 @ 70/lower (-5.7%)

In a nutshell:
For (net) $12.50, your losses will be limited to $437.50 below 70.00 by the purchased put. The tradeoff is that your potential profit will be limited to $2062.50 above 95.00 due to the call sold. *Above 95, you will probably be assigned and deliver stock at 95.

BEARISH

Situation:
DJX @ 88.50. You are bearish, looking to limit risk but be rewarded if you are right.

Outlook:
DJX to decline by 5% over the next 2 1/2 months

Possible Strategy:
Bear Spread:
Buy 1 DJX Sep (00) 90 put @ 3 1/8, sell 1 DJX Sep (00) 85p @ 1 3/8 , ($175 debit)

Change
DJX at expiration
Sep 90p value
Sep 85p value
Spread Value
Profit/(Loss)
+0.60%
90.00/higher *
0
0
0
(175)
-0-
89.50 **
50
0
50
(125)
-1.40%
88.25 ***
175
0
175
0
-1.70%
88
200
0
200
25
-2.80%
87
300
0
300
125
-3.90%
86
400
0
400
225
-5.00%
85.00 ****
500
0
500
325
-6.10%
84
600
100
500
325

AT EXPIRATION (8/25/00):
* Max loss: $175 at DJX 90.00/higher (+0.6%)
** Unchanged: $125 loss
*** Break-even: at DJX 88.25 (-1.4%)
****Max gain: $325 at DJX 85.00/lower (-5.0%)

IN A NUTSHELL:
Possibility of a $325 maximum profit on a $175 investment if index drops 5.0%. If index is unchanged or higher, maximum risk is $175.


CBOE Volatility Index (VIX)