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Wednesday, August 13, 2014

Buying Calls Instead of Stock Strategy Video -- Update on POT Example

For today's blog post, I thought I would include my silent video titled: "Call Instead of Stock Strategy (CIS): A Stock Replacement Strategy That Efficiently Utilizes Your Capital".


I produced this video on March 9th 2014. The video identifies 8 ideal strategy criteria that I use when implementing a CIS candidate.  The example shown in the video is a real trade I initiated with Potash Corp. Of Saskatchewan Inc. (POT) options. For the record, I am still "technically" in what has turned out to be a long-term option position. My original expectation would be that I would have been out of the trade long before now! Since this trade was initiated on March 7th, 2014, all original options have long since expired or have been rolled out in future months. The original CIS POT options trade that I put on was as follows:

POT underlying Stock Price @ ~$34.68 on 3/7/2014                                    
                                 BUY +3 JUN 30 Calls @ $4.95 = -$1,485.00 
                                SELL -1 APR 36 Calls @ $0.59 = +$    59.00
                                BUY +3 APR 36 Puts @  $2.19 = -$    657.00
                                SELL -6 APR 33 Puts @ $0.58 = +$   348.00
                                BUY +3 APR 30 Puts @ $0.09 = - $     27.00
                                Original CIS TradeNET DEBIT =-$ 1,762.00

The original CIS net deltas for such a position as above was approximately +195. The breakdown of the +195 deltas is calculated as follows:

                               +3 JUN 30 Calls ~+85 deltas X 3 = +255 deltas
                               -1 APR 36 Calls  ~-30 deltas X 1 =  -  30 deltas
                              +3 APR 36 Puts  ~-80 deltas X 3 =  -  240 deltas
                              -6  APR 33 Puts  ~+45 deltas X 6 = +270 deltas
                              +3 APR 30 Puts  ~-20 deltas X 3 = -    60 deltas
                                Original CIS Trade NET DELTAS= +195

The +195 option deltas position I originally had with POT as the underlying, equates to having +195 shares of stock in POT. Had I instead purchased 195 shares of POT, my net cost would have been $6,762.50 (POT @ $34.68 per share X 195 shares).  So, when I say that options are a more efficient use of one's capital for essentially the same amount of risk exposure this example should show this clearly.  In other words, the outright stock purchase for 195 shares at $6,762.50 versus the purchase of longer term calls with some nearer term downside protection hedges costing only $1,762.00 frees up nearly $5,000 of your capital!  

So what happened to these original option positions you may ask?  First of all, POT itself barely moved by the end of April expiration...$34.57 per share.  The longer term JUN 30 calls lost about 16 cents to $4.79 ($4.95-$4.79), or ~-$48.00. Of course the one APR 36 short call later expired worthless meaning the underlying price of POT never reached $36.00 per share. This resulted in me keeping the entire premium of 59 cents, or $59.00.  As it turns out, I would have benefited much more had I sold 3 APR 36 short calls, but I did not want to "collar" the trade fully, thinking POT would rise in the near term. Finally, the put butterfly hedge: +3 APR 36 puts were sold on April 17th for $1.17; or -$306.00/ -6 APR 33 expired worthless; or +$348.00 / +3 APR 30 expired worthless; or -$27.00. So, the put butterfly hedge managed to net a gain of $15.00 ($-306+$348-$27).  Thus, the overall position as of April 17th, 2014 was up a measly $26 bucks! 

The discussion of this CIS trade will be continued!  

Happy Trading!
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