Whiz is bullish on WYNN figuring a buyout or name change will boost the stock. He actually surprised me today and bought medium length calls (June 190 strike) and is selling weeklies against it. First time I’ve ever seen him try this on something less than the following Jan. Has he been doing stealth flybys here at The Bistro? 🙂 🙂

Anyway…a couple guys in the TGO forum, (The Ready Room), were asking about trade management on these. While I was writing up my response I came across something I found interesting that I hadn’t really considered before. We obviously worry about the issues we have to deal with when the stock drops and what is our max loss. On the other hand when the stock is screaming up it can also start showing losses. Here’s what I noticed and I can’t believe I didn’t see this a long time ago:

Losses to the upside are capped! How can that be? When running the Whiz trade through the TOS Analyze tab I noticed losses to the upside increasing up to a point and then sort of leveling off and the finally stopping at a certain point. I would say the point the losses stop is when the long call (at whatever length of time it’s at) reaches a 1 delta which finally equals the long delta of the short term call sold. It takes a pretty extreme run to get to that point but I found it interesting anyway. Any thoughts on that and am I seeing it correctly?

Here’s the post I made to the TGO forum in regards to his trade of buying June 190 calls and selling next week’s 190 calls:

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Great summary Kevin! I trade these types of trades all the time using various time intervals and tactics. I usually go out a little further in time since I’m a big believer in being able to safely sell enough weeklies to cover the absolute worse case scenario max loss of any of these, whether it’s synthetic or just buying the calls outright.

One obvious risk of these is the stock falling by quite a bit. That would force you to sell weeklies at strikes well below your long position in order to receive enough premium to cover max loss. Some trading platforms actually INCREASE margin requirements in this situation since the weekly call sale is effectively blocking profits on the longer term position. It doesn’t factor in the plan to roll the weeklies up and out if they get run over.

Another not so obvious risk of these types of trades is the stock going up too soon and too much. Due to the gamma risk of the short term call sales the overall position can actually begin losing money as the stock rises if it goes up too quickly. Worse case would be something extreme like waking up Monday morning and finding out WYNN is being bought out for 300 dollars per share (remember the surprise buyout of GMCR a few years ago?). Running Whiz’s new trade through the TOS Analyze tab I show it beginning to lose money at about the 197 level. On the bright side, once the delta of the long term and near term calls both reach max value the upside loss is capped. In this particular trade that happens at about $305 per share and capped at about a $995 loss per contract.

I generally monitor the overall delta of the position and if I see the stock starting to run and my deltas are approaching zero or less I’ll start looking to roll the weekly up and out. If deltas approach zero a second time I start looking to take some profits.

Here’s the first thing I looked at when I received the new trade…

Buying the Jun 190 calls at about 11.00 with 13 weeks to run I would need to sell about 85 cents per week of weeklies to cover that. That gives a good starting point on what weeklies to sell. It’s looking like for now that’s going to be about 7 or 8 dollars out of the money. Is that giving it enough room to run? Who knows? I sure don’t! My preference would be to go a little further out in time on the long calls reducing the weekly sales required to cover them giving the stock a little more breathing room.

These types of trades seem simple on the surface but there are a lot of moving parts to them…

Good luck!