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You can see, as Vega decreases, that we would actually make more money, as volatility decreases. Right now, it’s at 79% for these options.
If, in fact, we decreased the volatility, as I’m doing here on this volatility adjustment, by 2% – you can see that already, the profit that we would make on a daily basis, would increase slightly.
Let me bring that back to zero, in case you didn’t see that. At the current volatility level, you can see that our profit and loss would be a loss of $10 on the day, as soon as we put on this position. If volatility were to decrease by 2%, now, we have only lost $2.86 for this day.
As the price of stock increases, it will also decrease volatility. The reason that we can get this good of a price on these options is because the volatility is at 79%.
Here’s another thing to consider. With volatility at 79%, look at the December options. If you go out to the December options, the volatility is only 57%. That’s a huge positive skew. Let’s say you were interested in owning this stock, but what you would really like to do is not only own this stock at $17.50, but have your protection in for a longer period of time.
What you could do, then, is purchase a diagonal. You would purchase a diagonal by selling the July $17.50 puts, and buying – we don’t want to do September. We want to do December, because it’s a lower volatility. The Septembers are still at 71%. If we go out to December, now our volatility is only 57%.
At 57%, we have a positive skew of close to 27% between the July options and the December options. If we were to do a diagonal on that, our debit would only be 52 cents. We’re collecting 66 cents on the sale of these $17.50 puts. If the stock goes absolutely nowhere, we make good money, based on the sale of these $17.50 puts.
If the stock declines, and we purchase the stock at $17.50, now we have a long-term option, the December 08 option, at $15 as protection. We get assigned the stock at $17.50. We have 500 shares at $17.50, but we have a long-term put, a December 08 put, at $15. That’s a very attractive scenario.
If the stock stays approximately where it is, right around the $19 level, this $17.50 put will expire worthless. We’ll collect the entire $300 that we collected when we sold this put.
Now what can we do? Pretty soon, after these July options expire, we’ll have August expiration. Because we own a long-term, a long-dated put at the $15 level in December, now we can also sell the August $17.50 puts, when they become available.
Do you see the power of this? The power is that we have a long-dated option, a December option, at the $15 level, that we own. We are long. We can sell against that at the July option. We can sell against that at the August option. We can even go out to September, now, and sell another set of options. We can go out to October and sell another set of options.
In other words, every single month from July to August, September, October, November, we can sell each month, another set of options, against the five that we own in December. As we get to the December options, because we own those $15 puts for December, we can even turn that into a credit spread, or a debit spread, for the December month.
In other words, we still own the December $15 puts. We can sell again the $17.50s, to create the sale of a vertical spread. Or we can sell the $12.50s and create a debit spread. We can sell every single month between now and December, any of the puts that we want, because we are protected by those $15 puts.
It turns into a very attractive scenario. In July, right now, we can sell these for 66 cents. As they get closer to expiration, there’s going to be no value left in those, if the stock remains the same or goes up slightly. The very next option expiration after these July options expire will be August.
They only put the next month option up after the current month expires. Then they have some longer-dated options, as you can see here. After the July options expire, the August options will be available, that you can sell again.
These five December $15 puts are going to cost us approximately $1.21, as you can see here. In order to break even on the purchase of this put, we would have to sell approximately 2 months of options. If we sold this in July, and we collected 66 cents for it – if we went out to August, and we were able to collect another 66 cents, and we kept the entire premium without getting put the stock, we’ve already covered the stock of our $15 put.
That $15 put is absolutely free to us now. In 2 months, we can pay for this one put that we purchased, if the stock continues to move up. That means that in September or October, we could write another set of puts against those $15 December puts, collecting even more money.
Not only are we able to collect an income, while we’re waiting for our stock to get to $17.50, but we have a long-dated option to protect us from any downside risk, if we are put the stock. It’s a very attractive strategy.
Now, you can do this on a single stock, or you can do this on multiple stocks. It all depends on how much capital you have to work with.
I mentioned Bank of America. Let me ask you a question. Do you think there’s a potential for Bank of America to go out of business completely? Think about it. It’s either the second or third largest bank in the United States. In fact, it’s one of the largest banks in the world.
How likely is it, that they’re going to go out of business? Not very likely. They’re going to be around a long time. If that’s the case, then does $27.10 for the price of Bank of America stock look attractive to you?
It might, but let’s take a look at a really long-dated chart. Let’s go back 20 years. You can see that Bank of America stock has been as low as $12.50, going back to 2001, and even lower than that, if we go way back, when it was a much smaller bank.
It’s had quite a run up, hasn’t it? If we apply very simple technical analysis to this stock, you can see that it broke through at the $25 level, back in the middle of 1998. It hit it, came back down, and then broke through in 2002. It continued up from there. Now we’re getting close to that $25 level.
At that $25 level, that might be a very attractive price for an entry. In general, what happens is that breakthrough, that area at which the stock broke through, becomes support. Prior resistance usually becomes support.