Synthetic Long Johns?

Even though my CFC and WCI option strategies backfired, my JRCC puts did quite well. Enboldened by that success, I decided to try some more option trading.

I’ve been keeping my eye on Seabridge Gold (SA) for a few months now. A few months ago, I sold some naked puts on SA hoping that it wouldn’t drop more than $2 and I would get to keep the premium when the options expired worthless. It worked out exactly as planned and I made a few hundred bucks on the trade.

I’m still bullish on the stock and yesterday it gapped up on very high volume with absolutely no news. The options jumped too, but late in the evening the stock trended back down and filled the gap. The options dropped as well and I bought some November 17.5 calls for 1.95/contract. I also sold an equivalent number of November 15 puts for $1.35/contract bringing my net price to $60 per 100 shares.

If SA continues its rise, I should make some decent money. If it drops a few bucks, I’ll actually lose money, but I’ll probably have lost less than if I had bought the stock outright.

Buying a call and selling a put is called a synthetic stock position (technically, synthetic long stock) because your position mimics the behavior of the underlying stock so its like you’re artificially creating a stock. Its a cheap way to enter a position. Its not risk-free or a low-risk position but a simply a way to leverage your investment (and thus amplify your winnings or losses).

For an out of pocket investment of $60, I’m controlling $1650 worth of stock. The Delta of the November 17.5 call is 0.52, which means for every $1 move in the stock the option should move $0.52 in the same direction. As the price moves closer to the strike price of 17.50 and the time till expiration decrease, the Delta should increase. For the June 17.5 call, its 0.927 so it closely mimics the behavior of the stock.

If the stock moves $1, based on the Delta of 0.5, the option should (theoretically) move up $0.5, which means my $1.95 call option is up 25%. The put option will similarly lose value and I can close out at roughly a 30-45% profit. (Yes, this is a gross simplification. I’m not going to explain further because its 4 am and I haven’t slept for 2 nights – more on that later).

I’ll let you now how this trade works out.

NOTE: Do not blindly copy this trade. If you lose money, I take no responsibility whatsoever. (But if you make money, please send me a cholocate chip cookie!).

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