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American Capital Agency Corp. Message Board

  • reits_r_us reits_r_us Jan 1, 2011 1:18 AM Flag

    Synthetic stock..Cat-OT


    I've been reviewing the rational behind this trade we put on today. For those that are unaware it was on FCX. We bought the 119Jan call and sold the 119 Jan put for virtually no cost. This is a bull straddle or a call long staddle or the same thing as going long the shares, hence"synthetic" long position.

    In arbitrage the professional trader will often hedge his long synthetic position by shorting the same # of shares. The reverse of this is true also but I don't want to muddy the waters right now.

    So let's stay with my example of what we did today in the above trade but let's give ourselves some downside protection by the following eg.

    Fcx PPS @ 120. Buy 10 120 calls for 4.00, and sell 10 120 puts for 4.00. These aren't exact values (but close). Net cost zero. If PPS rises you make money on the gain in the calls AND on the lowering of the put premium which you can now "buy back" @ a lower price than what you sold it for. So win/win.

    If the PPS goes down you lose money on the puts because you have to buy them back for more than what you sold them for. So to eliminate this possibility at the time you enter your trade "short" 1000 shares of FCX. 1000 equals the 10 contracts of puts you sold.

    Now, when the PPS goes down to 116(example) or 4.00 you lose 4000 from the puts going down but you are "covered" by the short position of 1000 shares, making 4000, for net zero.

    On the up side, if the PPS goes up to 124, you gain 4000 on the calls, you gain approximately 2500 on the put decay and you lose 4000 from the short share position, for a net 2500.

    Yes you would have made 6500 without the short shares but the short shares are your insurance. Protecting downside means less upside but less risk.

    What do you think?

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    • Hey One,

      You got me with the Eeyore quote (brought back memories; the university that I attended celebrates Eeyore's birthday every year). I'm going to take a look at DEPO. Thanks for the tip.


    • Isn't this the exact position that the MM's put on to eliminate their risk? For example: You want to sell a call but there is not a retail investor to take the other side. The MM buys the call you want sell, sells a put and shorts the stock for a delta neutral position. MM does not care what happens as the gain/loss on the stock covers the gain/loss on the options. The MM wants to keep the bid/ask spread to put in his pocket. Obviously the number of shares would be adjusted as the deltas change.

      • 2 Replies to JetCityExpo
      • The big boys have quants whose job is to study anamolies all day long. They also have capital that we don't.

        A professional money manager explained it to me when I was telling him what I was doing.

        He said that when professional money managers trade their own money they often have a huge issue with risk capital, meaning making average returns with less and without being bail themselves out with lots of capital.

        For me, I live with a return of 5% to 10% on share trades and 15% to 50% option trades. If I could afford paying for me calls with ATM or NTM put sells, I would.

        However, what would happent to me is that I would end up reserving my account (including margin) for the possible purchase of shares under the sold puts. I don't really want to own portfolio right now, but would rather just trade certain options that I can afford.

        My hats are off to all of you buys who can take on more risk than you can afford, and I do it all of the time with calls. This morning, I would have had to excercise of 30,000 sharees to make my calls good, but I trade out of my calls when I am up so I never am in this positoin. If I then combined this type of trading with selling puts, I think I might have to tell me wife that our life savings are gone.

        So, I try and stay within boundries I can make good on. If you have an indefinite amount of capital, then a fast money trade you can be.

        Good luck to all. What a great start to the new year!

    • Hey One,

      Frightening dichotomy. I'm slowly looking through my notes in a good old fashioned spiral notebook, while the high-frequency traders are using super computers to comb through every piece of relevant data on the planet. Not quite a level playing field. As these imbalance anomalies are temporal and not causal (at least from our perspective), it may be tough to beat these guys to the "carrot". Oh well.


    • The only way you can profit from this position is if the initial trade for the options results in a credit to your account and you leg into your short stock position at a level that is > (option strike prices - net option credit per share), not including commissions. In this case you have locked in a profit at expiration.

      Example: GLD
      Short 139 Put Price @ Bid = $2.43
      Long 139 Call Price @ Ask = $2.20
      Net Credit = $.23

      In order to profit the short sale
      price of the shares has to be above
      the strike price - net credit of the

      Breakeven Short Sale Price = 139 - .23 or
      $138.77. Any short stock sale above
      $138.77 results in a locked in profit.
      However, don't forget commissions.

      This kind of trade might be interesting in a stock like AGNC during the dividend run up. For example, 1)establish a synthetic position with the puts and calls at ex-div or after a new stock offering, 2)Select the first options expiration month PRIOR to the next projected Ex-Div Date, 2) Short the equivalent number shares at a predefined level as the stock price runs up, 3) Buy back your shares at the options expiration.

      • 3 Replies to sbrown101750
      • Thank you only and Jbrown...that was very helpful. So if I can locate a stock that has a momentary put-call parity discrepancy I would be guaranteed the discrepancy credit either way. ie if the put is higher than the call go with a synthetic long combined with the short shares; if the call is higher than the put go with a synthetic short combined with the equal number of long shares. The shares protecting the short side of your positions, and the options already more than paid for with the credit. And....

        If the credit is above commissions this is a guaranteed win, no matter the stock goes higher, lower or sideways. Is this the way you both see it?

      • I am very boring and prefer buying the calls in FCX for May strike 114. I know it is simple, but my account is not large enough to afford the downside risk of purchasing a lot of shares.

        I do like the potential earnings release, the stock charts for FCX, the upcoming ex-divdiend date (and divdiend of (.50 that has been annouced) and the upcoming stock split. I also think cooper has done well and will continue to do well. ON that basis, May gives me plenty of time to repeat the benefit from an upwardly trending stock.

        I have 2 calls now, and will increase it to 10 as I wind out of my MLP positions. If the stock hit $125 to $130, I will make plenty.

        Your proposal is a good one, except your idea to short the shares obscures your opinion about the direction of the stock. I think it would add a lot complexity. Perhaps, you should buy some puts, but again it reveals a perhaps mixed view on the potential for FCX to put the hedge in place.

        Do you believe in FCX?

        The referral for FCX is one of the best ones I had in while, and I am grateful for it. Thank you.

    • One Caveat,

      Place this trade close to expiration( as this trade is...1/21) so that the put doesn't have much time premium and will hopefully expire worthless..

19.480.00(0.00%)Oct 21 4:00 PMEDT