Monday, January 12, 2015

using options to make that com-free etf work harder

i've been eating my own cooking on these commission-free etf's. rsx, the russian etf, is one of the etf's that i started accumulating because it was sporting a 5% yield. the yield has now moved down to the 4% handle so i have slowed my accumulation of rsx but i have accumulated 19 shares with all the up and down in that product. 

so now i want to show how the strategic use of options can make those measly 19 shares work harder. the action i took today was to sell a call vertical spread on rsx. here's the picture of what i'm talking about:
rsx bear-call vertical
if rsx is trading under 16 (14.80 at the time of this writing) in 39 days then these two options expire worthless and i will have lowered the cost basis on my 19 shares by $1.26/share because i collected $24 (net of commissions) up front against 19 shares. 

as the price of rsx moves above 16.24 at feb expiration then the vertical starts to be worth more than what i collected up front and detracts from the net-liquidating value of the total position. however, the shares will have improved in price by $1.44 or more in that case. the actual break-even price is at $16.54. here's a picture of the p&l analysis:
p&l graph for long 19 rsx shares and short call vertical
there is an excellent 72% chance that this position finishes in the under 16.54 price area, where i am better-off for selling the spread. there is a worse-off price area between $16.55 and $19 that has a slim 15% chance of occurring. above 19 the p&l starts to improve again and the upside-profit is actually unlimited, just diminished by the $80 it will take to buy back the spread.  if you are building wealth from scratch and choose to copy me on this strategy then stop buying the underlying. on the slim chance that rsx does take off to the upside you could then sell 5 or fewer shares, commission-free, to cover the spread repurchase cost.

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