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I was reading Dollar-cost averaging using an option strategy.

Consider one month's investment of $30k. Looking at the VTI options, selling at ATM straddle expiring on June 21 worth $3.04 + $6.91 = $9.99 (6.7% of strike). So if I wanted to buy 200 shares of VTI ($29.4k), then I could instead buy 100 shares ($14.7k) and sell the ATM straddle.

Then here are the possible results,

  1. VTI < Strike. Put exercised. Same ending position as if I bought 200 shares + 6.7% earnings
  2. Strike <= VTI. Call exercised. Re-buy stock at higher price and earn (or lose) 6.7% - price change

Did I get this right or are there other costs I am ignoring aside from transaction costs?

  • @aidan.plenert.macdonald - Your quotes have some problems. If you're selling the ATM straddle, the call and put prices will be similar. At $3.04 and $6.91, you are either selling a strangle or you have bad quotes. Please provide the strike price of the straddle and then I'll tell you how the web site you're looking at makes this more complicated than it should be as well as some small mistakes in your analysis. – Bob Baerker Apr 10 at 19:17
  • @Bob Baerker: I am reading the OP's question again.. Is what he is describing even dollar cost averaging? – sofa general Apr 10 at 20:28
  • @sofa general - the OP is quoting the description in the link that he cited. You are correct, it's not DCA. It's averaging down. – Bob Baerker Apr 10 at 22:40
  • @sofageneral I should have mentioned that I would be doing this frequently over time and my goal is to lower the cost basis of my investments – aidan.plenert.macdonald Apr 10 at 23:21
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Here's the example in your link:

Buy 100 shares of RCL at $72.22

Sell 1 call option Nov $72.50 for $3.40

Sell 1 put option Nov $72.50 for $3.65

If RCL < $72.50 at expiration, the call expires worthless. The put is assigned and another 100 shares are bought at $72.50 less premium received. The net cost of the 200 shares is $68.84 ($72.22 - $3.40 and $72.50 - $3.65) which is $3.38 less per 100 shares versus buying the 200 shares outright.

If RCL > $72.50 at expiration, the put expires worthless. The call is is assigned and 100 shares are sold at $72.50. The gain is $7.33 ( -$72.22 +$3.40 +$3.65+ $72.50).

Let's dig a little deeper. Covered calls are synthetically equivalent to short puts of the same series. That means that the return of each will be similar. Knowing that, the RCL Nov $72.50 covered call is equivalent to selling a Nov 21 $72.50 put.

So instead of doing 3 legs with the long stock and short straddle, just sell two Nov $72.50 puts for $3.65 each. If assigned, your cost basis is $68.85 (one cent more than the covered straddle). If the options expire, your gain is $7.30 (3 cents less than the covered straddle).

In addition, you executed the two put position with only one leg so that was two fewer commissions on entry and possibly no commissions on exit should the options expire worthless (that's not going to happen with the covered straddle).

As for your conclusion of "Re-buy stock at higher price and earn (or lose) 6.7% - price change" if the call is exercised, I'd suggest that you look at this differently.

If the call is nicely ITM, don't buy the stock back. Covered calls and equivalent short puts is an income strategy. If you want ownership, don't sell covered calls.

If you want income, let the stock go via assignment unless the call is only modestly ITM and you can get some worthwhile premium for rolling the short call out (and possibly up). Do not wait until an option is deep ITM if you want to roll because the further ITM it gets, the more that the time premium dissipates.

Web sites like this one present unnecessarily complicated strategies. I don't know whether that's because of ignorance or because they want to appear more savvy than they really are.

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OK OP let's take a lot at this strategy and try to figure out what it is actually doing.

Buy 100 shares of RCL at $72.22
  Sell 1 call option Nov $72.50 for $3.40
  Sell 1 put option Nov $72.50 for $3.65  (this is a naked position by the way)

This is a bet that the stock won't move much.

if it goes up to 72.5 exactly. you will pocket 7.05 + .28 = 7.33for the underlying stock. per share.

if it goes up to 100, you will pocket $7.33 exactly. leaving $20.17 on the table.

if it goes down to 50, you will pocket the $7.05 premium, but lose 22.22 on the underlying stock, AND another 22.5 on the Puts. Your net loss would be $37.67.. (assuming 100 shares and 1 put that's 3767).

if it drops to 70, you make a little, 2.33 if it drops to 68.8, you start to lose money.

This strategy heavily caps your upside... and amplifies your downside... you only win if nothing happens...

Can you use it for something ... sure (i don't know what it is ).. in any case, this is not the kind of stuff that excites me.

if you want a limited up side strategy, without the extra downside risk... what is wrong with just selling covered calls? (that caps your upside... but doesn't amplify your downside).

if you want to live dangerously and bet on nothing will happen.. why not just sell naked calls and naked puts (you are already naked one way ... why not naked the other way too?) I am NOT recommending this at all.. just making a point.

  • 1
    Your statements are contradictory and incorrect. The OP is comparing a covered straddle (CS) with buying 200 shares outright. There is no amplification to the downside with the (CS). What can you use it for? Income. That's the primary purpose of covered calls which is what the (CS) is equivalent to. But then you ask, "What is wrong with just selling covered calls? (that caps your upside but doesn't amplify your downside)?" That's exactly what he's considering with this strategy. Selling a naked straddle (living dangerously) has a very different risk graph and is not appropriate to the CS. – Bob Baerker Apr 10 at 22:53
  • I'm not an expert with options, but I believe @BobBaerker is right. I am selling two options. A covered call and a cash secured put. As far as I understand, none of the options are naked and my losses are only as much as I would have had owning the stock. – aidan.plenert.macdonald Apr 10 at 23:31
  • @aidan.plenert.macdonald - The covered call and the cash secured put are equivalent positions. It's the same as if you has sold two covered calls or two cash secured puts. You can read about synthetic equivalence here: optiontradingpedia.com/syntheticpositions.htm . One small detail - your losses will always be less than having owned the stock outright because of the option premiums that you received. – Bob Baerker Apr 11 at 0:04
  • a cash secured put........ .... ahhh... missed that part... (then again it is not something i am remotely interested in...) You won't go broke... but you are tying up a lot of capital for a significant amount time for a max of 5%... but your max loss is why more than 5%... you can't scale this up... . AND your down side is still amplified..... – sofa general Apr 11 at 14:10
  • @Bob Baerker: I am only looking at the scenario you were looking at. I didn't address the OP's question. :P As for the OP. His question is badly phrased. The key to his question isn't the play, but the environment and his thesis for using that play now. Why VTI? Why now? what is he expecting to happen.. Why he thinks this strategy would perform well under that scenario. By the way... if his thesis is VTI has peaked for the short term(Q2), but will rebound in the medium term (by Q3 or Q4)... he might be able to at least make that play make sense from certain point of view – sofa general Apr 11 at 14:17

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