Potentially Grab Portfolio Gains Without Buying Shares or Risky Options
So how exactly do you chalk up a $4,600 profit on one of the market’s biggest oil stocks… without even buying the shares, or a risky option?
This little-known strategy combines the best of all worlds:
- A low purchase price.
- Unlimited return potential.
- A downside that was identical to owning the shares.
In fact, the move in the investment was almost dollar-for-dollar on the upside and dollar-for-dollar on the downside, compared to owning the actual shares.
Here’s how the trade worked – and how you can do it yourself…
Do You Want to Pay $36,000 for 1,000 Shares… Or Just $12,000?
We executed the trade on Brazilian oil giant, Petrobras (NYSE: PBR).
At the time of entry, the stock was trading for around $36, so a 1,000-share purchase would have cost $36,000.
However, the Petrobras $25 January 2013 deep-in-the-money call option was trading for $12. So in buying 10 contracts, which equates to controlling 1,000 shares, the dollars at risk were 66% less than if we bought the shares ($12 multiplied by 1,000 = $12,000).
Now, let’s look at the downside…
If you’d bought the shares and assigned a 20% stop loss, the stock would have to fall by $7,200 before you’d be stopped out. That loss would be almost identical to a corresponding loss for the option, which is typical of deep-in-the-money options.
The terminology for this is a high delta trade. Delta simply refers to the change in price. A delta of 100% would indicate an identical change in the price of the underlying stock and option.
Here’s how the trade played out…
Investment Utopia: Bigger Gains With Lower Risk
When Petrobras shares traded up to $40, I recommended selling the options after just a couple of months.
Result? About $16.60 for the sale – a gain of around 38% on the original investment, or $4,600 in net profit ($16.60 minus $12 multiplied by 1,000 shares = $4,600).
Compare that to a regular shareholder, who’d have seen a gain of $5,000 – only $400 more than the return on the option trade, or about 14%. And that was having put 66% more capital at risk, too.
So the next time you want to invest in a blue-chip stock, consider using the high-delta, deep-in-the-money strategy to:
- Reduce the dollars you have at risk.
- Own more companies with your capital (diversification).
- Increase the return on your investment by a factor of three to four times.
- Maintain the same downside dollar risk.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official position of Wall Street analysts.
About Karim Rahemtulla
With more than 20 years of experience, Karim has mastered the subtle art of options trading. What we admire about him is his ability to score huge gains while minimizing the massive amount of risk that often comes with options. Beyond his expertise in options trading, he is also the author of the best-selling book Where in the World Should I Invest? He publishes weekly about smart speculation in his latest free e-letter, Trade of the Day.