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IBM closed at $127.04/share, up $1.11/share from the previous
trading day. Let say we are bullish about IBM and expect the stock to
move up 10 points from now to January 22nd, 2010. We buy 100
shares of IBM stock at $127.04/ share today and also buy IBM January 125
put IBMME for $5.30/share or $530/contract.
Let analyze our trade here:
If we buy 100 IBM shares at $127.04/share without buying the put
protection, $12,704 of our capital is at risk. In other words, if IBM
stock drops to $0, we lose all of our $12,704 investment. If IBM stock
moves up to $137/share, we reach our target price and get out with
$9.96/share profit or 7.84% (9.96/127.04).
If we buy 100 IBM shares at $127.04 and also buy IBMME put for
$530/contract, we own the right to sell IBM stock at $125/share until
January 22nd, 2010. Our total expense is $13,234 ($12,704 +
$530). If IBM stock drops to $0 before January 22nd, 2010, we still have
to right to sell it at $125/share and our loss is only $734 ($13,234 -
$12,500). If IBM stock goes up to our target price at $137/share, we get
out of the trade with a minimum of $4.66/share profit ($137 - $127.04 -
$5.30) or 3.52% (4.66/132.34). The reason I say minimum of $4.66/share profit
is because if IBM stock reaches $137/share before January 22nd,
2010, we sell our stock and we can also sell the IBMME put for whatever
value it has left since we are out of the trade, we don’t need the
insurance any more.
Please notice in this Synthetic Call Strategy example, we buy
insurance to protect ourselves for the next 3 months. Is 3 months
protection always the case? Absolutely not. We can buy more or less time
for the insurance depends on the investor trading philosophy. We can also
buy insurance at ITM, ATM or OTM strike prices depends on the investor
experience and the support level of the underline stock.
Please also notice when trading the Synthetic Call strategy, our
profit is consequently less because of the premium we paid for our insurance.
Is there any way we can “finance” the cost of buying insurance? Of
course, there is. We will talk about that next lesson.
Dennis Phan 潘家墉
20 October
2009
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