Quote:
Originally Posted by AnnAfromAlabamA
and so in the microsoft example, a normal, intelligent person would be expected to make on average only about $652 from the $5000 by exploiting the information they had, since what they would do is buy 200 shares (about all they could afford) of MSFT at 24.68, then buy 2 put contracts with a strike of 23 for $.02, sell the 200 shares at 19.74 and make $652 (23-19.74=3.26; 3.26x200=652). That sucks a lot.
You're looking at it the wrong way. You describe a regular put as if it were a naked put. In your scenario above as a naked put you've still made a healthy 16.5% on the trade. I'd call that not a suck. You're looking at it in terms of dollars made.
In the scenario of a regular put (you first own the stock before the drop and the exercise):
You buy 200 shares at $24.68, thats a cost of $4,936.00 (+commission)
You buy your $23 strike put contracts (+option comission). The stock drops to $19.74. Your position is now worth $3,948.00, a drop of -$988 or -20%
You exercise your put contracts and sell your 200 shares at $23 or $4600.00 (-comission).
So instead of sitting on an unrealized -20% loss of -$988, you have a realized loss of -6.8% or -$336 (-option cost). It might have taken 1, 2 or 4 years to recover that $988 (a 25% gain to get back even) . Meanwhile you might find a place for the saved $652 that returns better than Microsoft. Or you could simply plow it back into Microsoft. So instead of having $3948 invested at $19.74 (and an unrealized loss), you now have $4600 invested at $19.74 and a realized loss of $336 that can go towards offsetting a realized gain of $336 from something else.
Last edited by nuclear500; 06-24-2011 at 09:12 AM.