Word Count: 525
Time to Read: two minutes
Hey there again sports fans! I want to follow on yesterday’s post ever so briefly today with a side-by-side comparison of the RadioActive Trading style of Married Put… to the often-touted leveraged play of buying an In The Money Call Option.
So, here’s one of the stocks from yesterday’s selloff: ALTR. I mentioned that last time I had played ALTR, it paid me handsomely: 12% (well, okay, 11.9% after commissions). Yesterday’s ALTR exit got me out at a leeedle 5.6% loss whereas the stock actually declined by 21.8%.
So my most recent challenger wants to compare my winning trades with his entries and show how much better than mine they would turn out. Okay, I’ll play. Here was my winning entry with ALTR on September 14, 2010:
ALTR shares trading at $27.35
Buy Mar 2011 $29 put at +$ 3.50
Total Invested $30.85
Guaranteed by Put: -$29.00
Total Amount AT RISK: $ 1.85 or about 6.0%
Now, without getting too steeped in the details… my ALTR trade returned, as I said, 12% before commissions. I closed the position on 11/5/2010 for that modest gain. Okay, so let’s look at an In The Money Call Option purchased on the same day:
Buy To Open March 2011 $20 call option: $8.30
Fast forward to November 5, 2010… the same day I got out of ALTR. Those March 2011 calls are way up to $13.10!! Nice going, MarketMaker (my challenger’s handle)!!!
November 5, 2010 Sell to Close March 2011 $20 Call Option $13.10
Entry on September 14, 2010 -$ 8.30
Net PROFIT $ 4.80 or 57.83%!
Okey dokey. Fair enough. The In The Money Call Option produced a 57.83% return in exactly the same time-frame as my Married Put setup only earned a piddly 12%. I give you that…
Now. Let’s look at my more recent trade on ALTR, the loser:
ALTR shares trading at $48.47
Buy Jan 2012 $55 put at +$ 9.80
Total Invested $58.27
Guaranteed by Put: -$55.00
Total Amount AT RISK: $ 3.27 or about 5.6%
This entry was done on May 5th, 2011. As you know, I closed ‘er yesterday for the maximum 5.6% loss. So let’s look back at the historical options data again and see where the In The Money Call Option would have been priced. On May 5th, 2011:
Buy To Open Jan 2012 $40 call option: $10.80
Fast forward (again) to yesterday: The Jan $40 calls are trading at $3.00.
Entry on May 5th, 2011 $ 10.80
August 4, 2011 Sell to Close Jan 2011 $40 Call Option -$ 3.00
Net LOSS $ 7.80 or 72.22%!
Now, don’t get all, “Well, if I was trading an In The Money Long Call I would keep a closer eye on the markets and get out well before that!”
Because guess what? If you get to say that, then I get to say that. I would not have suffered a whole 5.6% loss if I got out sooner either.
All things equal, which do you like more? The strategy that makes 12% when right and loses 5.6% when wrong? Or the leveraged position that brings in a whopping 57.83%… but then pays the market back and then some with a 72.22% loss?
Math is fun, don’t you think? 😉
Well, back to the drawing board… now that the market has had some air let out of its tires, and since my capital has been preserved by wise forethought and proper money management strategy… I think I’ll begin planning my next move.
Cat got yer tongue, challenger? Thought so.
Happy Trading,
Kurt
I'm Kurt Frankenberg, and I have discovered how to truly put the odds on the side on the individual investor.
If your Calls and Puts were the same strike the results would be close to the same.
You should compare Apples to apples. Instead of buying a DITM call @40, you should buy Jan 12 $55 Call for $3.00. Thus the risk is almost same (3.00 vs. 3.27 for the married PUT – but the rest of the capital is available).
Now, on Aug. 4 as you closed out – the Jan 12 $55 Call traded for $0.40 (according to ThinkorSwim closing price via thinkback). Assuming you can sell @0.40, actually you just lost 3.00-0.40=$2.60, much better than $3.27!
Yes this is a really bad example. The monetary risk should be the same so the example should show a more at the money call. The net loss if things go wrong should be equal on either trade. In othe words on the radioactive version the net potential loss is 5% capital invested in trade. On a long call version, the net los of 5% should equate to losing all of the value of the call. That should equal 5% of the value of the investment or in this case, portion of total portfolio. As far as I can see the long call is the same as married put. Where radioactive is useful is in teaching us how to address risk. In the example above I would quite happily risk 5% to take in 50% when the trade goes right. Try putting that into your risk spreadsheet and see what you get .. Even with only 50% winners!