High Risk Option Strategies

High risk option strategies

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No. The more legs you add onto your trade, the more commissions you will pay entering and exiting the trade and the more opportunity for slippage. So lets head the other direction.

Can we make a simple, risk-free option trade, with as few legs as possible?

The (not really) surprising answer is "yes", but there is no free lunch, as you will see.

According to financial theory any riskless position will earn the risk free rate, which right now is almost nothing, nada, 0%.

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Let's test this out with a little example.

In theory, a riskless position can be constructed from buying a stock, selling a call option, and buying a put option. This combination should earn the risk free rate.

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Selling the call option means you get money now but agree to let someone else have the stock at an agreed contract price if the price goes up. Buying the put option means you pay money now but can sell the stock to someone at a pre-agreed contract price if you want to do so, which would only be when the price declines below the contract price.

To start our risk free trade, buy Google stock, GOOG, at the Oct 3 Close:

495.52 x 100sh = $49,552

The example has 100 shares for compatibility with the options contracts which require 100 share blocks.

we will sell a call and buy a put @ contract price of $500 for Jan 19,2013.

High risk option strategies

Therefore we will receive $50,000 for certain on Jan 19,2013, unless the options clearing system fails, because of say, global financial collapse, or war with Aztec spacecraft.

According to google finance, if we had sold a call today at the close we would receive the bid, which is 89.00/share, or $8,900 total. And if we had bought a put today at the close we would pay the ask, which is 91.90/share, or $9190 total.

So, to receive $50,000 for certain on Jan 19,2013 we could pay $49,552 for the GOOG stock, minus $8,900 for the money we received selling the call option, plus a payment of $9190 for the put option we need to protect the value.

The total is $49,842.

High risk option strategies

If we pay $49,842 today, plus execute the option strategy shown, we would have $50,000 on Jan 19,2013. This is a profit of $158, the options commissions are going to be around $20-$30, so in total the profit is around $120 after commissions.

High risk option strategies

On the other hand, ~$50,000 in a bank CD for 12 months at 1.1% will yield $550 in similarly risk-free interest.

Given that it is difficult to actually make these trades simultaneously, in practice, with the prices jumping all around, I would say if you really want a low risk option trade then a bank CD looks like the safer bet.

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This isn't to say you can't find another combination of stock and contract price that does better than a bank CD -- but I doubt it will ever be better by very much and still difficult to monitor and align the trades in practice.