Every once in a while, it’s fun to take a chance.
Today we made a play on YRCW where we sell the 2011 $2.50 puts for $1.75 and sell the 2011 $5 calls for .75, which net’s us $2.50 on the $2 stock. We like YRCW and think they are undervalued here but that’s no reason to actually buy them in an uncertain market. The nice thing about selling the 2 naked leaps is that we have collected $2.50 and our worst-case outcome to the downside is that the stock goes bankrupt and we owe the put holder $2.50 back – making this a null trade.
Our real risk (our only risk) is to the upside. Our strategy for managing that risk is to put a buy on YRCW at $2.50 and a sell on YRCW at $2.50. In other words, we will buy it when it’s breaking over and sell it when it’s breaking under. Each time we do this, we may lose a few pennies here and therebut, if YRCW finishes over $2.50 by 2011, we will own the stock for free (we collected $2.50 and paid $2.50 for the stock) and will be called away at $5 – a VERY nice profit over 18 months.
Anything under $2.50 and we keep the net between $0 and the final price, giving the rest back to the put-holder. This is not the kind of position we worry over, this is simply a play to collect $2.50 and, hopefully, never give it back! Of course there are margin issues depending on your account situation that need to be considered. This is a variation of the Buy/Write strategy we love to use, only without the buy. If you did buy YRCW at $2 and sold the 2011 $5 calls and 2011$2.50 puts for $2.50 then you would be in the trade for a credit of .50. In the bankruptcy scenario there, you would have another round put to you at $2.50 and your average entry would be $1 – substantially more potential downside loss than selling naked. On the upside, you are in better shape as your basis of -0.50 would net you a $5.50 profit if YRCW closes over $5 and you don’t have to worry about getting blown out by a buyout of YRCW.
These kinds of plays are always risk/reward scenarios and, with that understood and out of the way – let’s…
