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American Capital Agency Corp. Message Board

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  • yourbestfriendintheworld yourbestfriendintheworld Jan 9, 2013 5:41 PM Flag

    Hey Ephort!!


    Why would the Jun 15 be called at March opex?


    You paid 25, collected 21, were paid 15, then paid 35 and ended up with 1000 shares.

    Your net cost in your scenario is -25+21+15-35 = -24 per share. Check.

    What you did isn't a strangle. A strangle involves OTM options, not deep-ITM options. I had to look it up, and it's called a "short guts". The deltas on the two positons cancel between the strikes, then your net falls off above and below the range, making it look like a short strangle. It brings in a lot more cash than a short strangle, but since you're pretty much guaranteed to be ITM until opex on both legs, most of that cash will go to cover being assigned both ways. You get to keep the time value.

    It also isn't a hedge for your shares. Your asset value with the shares has a delta of 1 between the option strikes. It's 0 above, costing you profit, and 2 below, doubling your loss. A hedge would decrease delta on the downside, whereas you've leveraged it.

    So you went net -4 to enter the position at p=25. You gain at 1:1 up to p=35, where your gains flatline with a max gain net of +6. Or you can lose at 1:1 down to p=15, where you are net -14, and if it continues to fall you lose at 2:1 until the stock goes to p=0, where you are at max loss net of -44.

    So by "saving" a dollar per share, you have given up all profits higher than $6 and taken a $44 risk. Your breakeven is at 29.

    (Really, your opening cost was $4, so you "saved $21", which seems like a better price to pay for all that end-result skew...)

    If you're going to talk about particular sequences of events and trajectories for the price, then your max goes up, but your risk does too. Just staying within the strikes and not trading the shares, you can keep the almost the total of the option premiums (21) if you are assigned the Put near 35 and the call near 15. But you can lose $40-21=19 if the call is assigned near 35 and the Put near 15. So there's a $40 range even without selling the shares, which you can do for a profit or loss as normal.

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    • YBF, I didn't follow all your explanations, but by my reckoning max gain is +11 (not +6) and max loss is -39 (not -44). (Not infinite risk, as I said earlier, but pretty substantial).


      Entry: -4

      Value @pps=35: stock=+35, call=-20, put=0, TOTAL=15 (net=11)

      Value @pps=0: stock=0, call=0, put=-35, TOTAL=-35 (net=-39)

    • YBF,

      "Why would the Jun 15 be called at March opex?"

      Because the deep ITM Calls track the PPS dollar per dollar(Theta = zero). IOW, the current Jun15Call traded @ 10.10 last, today.The PPS is 25.11, so the option is at Par.

      At Mar EX, it will also be at Par. The long holder of the option will exercise(99%) to receive the dividend. If he does his shares are worth 90 cents less, but he has received 90 cents in the dividend to remain neutral.

      If he does not exercise and instead keeps the Call, his Call will be worth 90 cents less, on the EX date and he will be down 90 cents compared to having received the dividend. This is why I added the Long share position in this hypothetical example. If you did not buy the shares along with the option spread, that exercise @ Mar EX, would leave you down 90 cents/share and short the shares from 15.00.

      Make sense?


      • 1 Reply to reits_r_us
      • When the short calls are assigned in March and the shares are called away, you are left with $11 credit and the short puts. The net value of the position will go up and down with the market, and will be $11 minus the value of the puts. From March until June, you are no longer protected down to 14 but only to 24. Getting an additional dividend will be nice, but you will be wide open to downward risk, no?

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