I have been following this board in silence for some time now, using your generous advice to make some money here and there, so thank you very much for sharing.
As for this combo, what's the advantage of doing all this vs just shorting the stock ? I do realize that the spread caps possible loss, but it only becomes effective after PPS of $88, which looks a bit far fetched in this scenario. Am I missing something here ?
Thank you for your kind words. The trade I outlined is a modified synthetic short position. I just placed a stop with the Long Call.
The reason for the hedged Call position is twofold. One, it does prevent upside loss on your short Call, regardless of its unlikely occurrence. Shorting un-hedged calls almost cost me my home on a margin call a long time ago...;-)
Second, it reduces your margin requirement by about 7 fold, changing it from $32,000 on 100 spreads to $220,000 on the un-hedged calls.
This last sentence is again a main difference between the short share position and the trade I outlined. On my trade for 100 combinations you are looking at again $32,000 margin compared to over $400,000 margin for the equivalent 10,000 shares of KMP short.
The disadvantage of my trade is the BE and max loss. BE is approximately 85.90, with the Feb87.50 Long Put and the Feb85.00/87.50 Short Call spread for a net .68 debit.
The max loss is .68 + 2.50 = 3.18 @ 87.50 or higher. This did happen back exactly one year ago. We had almost a 4.00 surge from the open on Jan EX date to the following Feb OPEX. You can mitigate loss by shorting the shares and placing a stop.
So don't bet the farm. If the debt ceiling thing gets settled before Feb OPEX all bets are off. Knowing our boys in blue(Congress), I'm not betting on that...;-)
BTW, that impasse should be almost through "slow cook" by Feb OPEX(2/15/13), meaning whenever the date certain for the vote on the debt ceiling issue, close out your position one day before that date.
After some DD on different plays I have modified my decision to incorporate your short shares with a Call stop. If we end up on EX date(on the open) @ today's PPS I would like to short the stock @ 88.65 and buy the Feb90Call for .32. I know these numbers will probably be different but they serve for a good proxy.
That would place your BE @ 88.33 on the short shares. Your max loss is the difference between the PPS and the 90 Strike + the .32 premium for the option giving 1.67, @ a PPS of 90 or higher all the way to Feb OPEX(Feb 15th).
It varies but the caveats are to not enter the trade if the open is significantly lower than the previous closes PPS minus the distribution(1.29). Last year at this time we opened 2.26 down on the open, with a dist of 1.16(not a good sign, and this trade did flop..btw, it was the lowest open cf to previous close in three years).
Second, the best average time to exit is 5 days post EX, going back three years. Third I would not get greedy(too) and set a limit order in to buy to cover for 3.00 below your short PPS(in the example above, 85.65). If by the 5th day you are not out and the daily PPS is not weakening day by day, I would exit with profit/loss, and live to fight another day.
Yes, you may lose out on a significant decline in the PPS by Feb OPEX, but the PPS has sailed away from that date(up) in the past also. So crumbs..3.00 would make me very happy for 5 days work...;-)