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Hi
Rt's,
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With Ira's
misgivings about his type of trade aside, here is another interesting one.
This uses Sprint (PCS). Buy the <FONT
size=3> PCS JAN 2006 7.5 Call (WVHAU) at the ask of $3.70 and sell the PCS
AUG 2004 10 Call (PCSHB) at the bid of $1.50. These are market orders but
improvements can usually be made with limit
orders.
The type of trades I
have been looking for are those that give a small Long/Short
price ratio. In this case it is 3.70/1.50 = 2.466. In addition
I want the long LEAP's to be more than 1 year out (2006) and the short
calls to be 1 or more strikes above the LEAP's.
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In this trade the
maximum loss is $220.00 per contract (excluding commissions). The maximum
gain is $225.80 per contract and occurs if PCS is at $10 at expiration on
08/20/04. The break even points are $6.91 to the down side and $41.86 to
the up side on PCS.
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The logic behind the
trade is this: I want a low Long/Short price ratio so that it would take
fewer trades to own the LEAP's for free. You can not interpolate this to
future trades but it helps to get a good start. Secondly, I want the
LEAP's to be far enough out in time to allow multiple trades before expiration
and likewise the short calls to be as close as possible. By selling
calls at a higher strike than the purchased LEAP's it "spreads out" the range at
which the trade will be profitable to between ^6.91 and 41.86 vs. using the same
strike for the calls and the LEAP's which results in a narrower, sharper
profile. The trade off to this is that the maximum risk is greater
and the maximum profit is slightly less. Also by having the long Leaps "in
the money" (7.50 strike with PCS currently at $9.85) and the calls out of
the money I am giving myself a slight edge at expiration. This may not
hold up, but every bit helps.
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There are several
possible outcomes to this trade. First if PCS is slightly below 10 at the
Aug expiration the short calls would expire worthless and I could sell
additional 10 strike calls to collect more premium. This is it ideal
situation for the long term. Secondly, if PCS is above 10 ( but below
41.86) the short options would be exercised and I could either allow the
position to be closed and take my profit or roll the short calls out (and
possibility up) to again collect additional premium. Thirdly, if PCS is
down below 6.91 the trade would be under water. While the short calls
would expire worthless, it would be difficult to collect sufficient premium by
selling even the furthest out 10 strike calls. Fortunately since I am long
the 7.50 LEAP's, I could sell the 7.50 strike calls and likely collect adequate
premium. The trade still might not work out if PCS continued to decline
but selling the 7.50's would significantly cut the potential losses
and create better opportunity for profit.
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If I can keep this
process going until I collect 3.70 in premium I will own the leaps for free and
can either sell then for a profit or exercise them and buy the stock for
$7.50/share. In the mean time I will have generated cash flow into my
account (interest, as Ira would call it) which to me is not a bad
thing.
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Comments
cordially invited.
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Good luck and good
trading,
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Ray
Raffurty
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