Dollar Cost Averaging with At the Money Straddle

Question

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?

Answer 1

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.

Answer 2

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.