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  • Question about buying calls – synthetic stock

    January 27, 2010 by  
    Filed under Options, Stock Trading

    QUESTION: I was playing around with SDS and noticed something interesting.

    If I buy a call (and not sell a put) I am limiting my loss to the premium paid yet am able to participate in unlimited gain. This way I don’t have to mess with buying the actual stock to set a stop.

    I guess I am wondering why establish the downside leg, except to receive a small credit?

    ANSWER: It depends on what call and what strike you want to buy.

    Here’s why call buying alone is not a good choice IMO:

    #1: You buy the call – so your entire investment is at risk.
    When the position moves against you and you sell your call then you have no position so you lose on the position and the commissions paid. Or you let the call expire worthless and you lode 100%. Or the stock moves in your favor but since the at-the-money call has a .50 Delta it does not move as much as you expect and your profits are limited.
    (SYNTH: when you buy synth stock you place the order to sell the stock at a pre-determined price giving you a snythetic STOP loss so you determine the loss – but it also keeps you in the position! When the position starts to move in your favor again you simply exit your stock position. If the position looks like it will never recover then you can simply exit the entire position at any time without further loss.)

    #2: You buy the call with less than a 1.00 Delta which means you lose money every day even if the stock moves in your favor or it just does nothing.
    (SYNTH: when you buy a synth stock position the short put in SDS will offset the long call loss due to theta decay.)

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