The Tycoon Report

Rent to Own ? Use an Option

Ever had a feeling about the direction of a stock or the market and been looking for the most effective way to play. If you use a vertical call or put spread you can be either long or short at a fraction of the risk and cost. Algebraically put spreads and call spreads can be viewed as a reflection of each other. Understanding the risk and reward of a vertical is a key basic building block of option mathematics.

How many times have you read an article or heard a compelling story or hard the urge to bet on the direction of the market and not followed you intuition and wished you had? Using options you can economically take directional bets with reasonable potential gains.

I get allot of calls from traders and friends describing their anxiety to take a position in a stock. Yet rather than “bet the farm” how about a vertical spread.

Let’s look a few examples. Apple has arguable the sexiest and the most popular product or products sold by any American company. At well north of 150$ per share therefore at least $15,000 dollars for 100 or $7,500 in margin to own 100 shares. If we used a 160 / 170 call spread out to October, December or January and we pay two, three or even four dollars that’s a net out lay of $200, $300, $400 we’d pay with the thought we could make as much as a thousand dollars every we time we do our spread.

If we were bearish Apple wouldn’t it be more reasonable to buy a put spread rather than use the thousands to short this name? The cost to buy this put spread would be less. The risk would be limit by the premium paid for the vertical. The potential reward of being long a put spread Apple stock would appear to be less also. But think about owning 50 Apple put spreads for say $3.00. Who could honestly sit and watch Apple go down ten dollars and not adjust?

Renting to own can also be used in the case where you have a stock you’ve wanted to own but aren’t absolutely sold on owning the stock. Let’s use Apple as an example of a stock we’re considering purchasing but not at $185. Apples is richly valued currently and we’d only own it if it got back to the 140 area. We could sell a January 150 / 140 put spread for $1.40., collect $140 every time we sell the spread. We are telling the market if Apple sells off to 148.60, by the third Friday in January we’ll buy Apple at that price.

Puts Spreads like this are being used by even the savviest investors. Warren Buffet has long term stock index options in his portfolio as a means of enhancing his portfolio. Professionals have used vertical spreads to own stock since the inception of options and you can too. Understanding basic mathematical relationship of calls and put spreads in the key.

Here’s “the rub” or the math behind call spreads and put spreads. The maximum profit on either is the difference between the strikes less the premium. For example, the Apple January 150 /140 put spread we collected 1.40 for is the same as buying the 140/150 call spread for $8.60.

So if thought Walgreens was headed higher and bought 25 /30 call spread for 2.00. What did I actually sell the 30/25 put spread for? 3.00.

If I bought the Rimm 85/90 call spread for $1.75. I can say that I synthetically sold the 90/85 put spread for $3.25

You now have the choice to outright buy a stock or more conservatively rent it with the idea you’ll buy it later.

Options give you leverage to “testing the water before you jump in” by limiting your exposure and your risk. Verticals can help calm the anxieties of chasing after a stock by setting a price you’ll potentially own at a later date. Understanding the math involved in a vertical call and put spreads gives you clearer understanding of the strategy behind using it.