02/13/2023

On December 9, 2022 I wrote an article entitled The Great Synthetic Stock Idea that you can pick up and read it by clicking the link in the title above. I encourage you to do this if you have not read the article before continuing with this one

On or around December December 13th I got an email from one of my readers that said he had implemented this idea on Microsoft (MSFT) and hoped that I was right. Well, since I never give advice on what to buy or sell (only education on how you may want to consider buying and selling) in these articles I sent him an email back wishing him the best and reminded him that I did not advise MSFT; that I only used that as an example. In fact, below is exactly what I stated in that article at the very beginning …

Now, not wanting a reader to get a leg up on me I decided that I’d better do the same thing so that if something should go wrong in his account I would have some idea of what he was talking about if he contacted me later about it.

The action I took on 12/14/2023:

Here’s an actual note from my brokerage account …

I did have the money in my account to purchase 300 shares of MSFT for an investment (cost) of about $77,166. As I write this article today, had I made that purchase MSFT, it is going for a price of $273.30. So, if I would have purchased 300 shares at a cost of $257.22 two months ago the investment today would be worth $81,990. Therefore in two months I would have made a gain of $4,824 or a return on investment of 6.25%. However, I would have tied up $77,166 of capital to acquire this gain.

Rather than do that I purchased 3 Call Option Contracts with a strike price of $265 per share, at a cost of $3,657.66 per contract ($10,972.99 total) or for $36.58 per share. To help fund this $10,972.99 to lower my cost and reduce my risk I also sold 3 Put Option Contracts with the same strike price of $265 per share, and was paid $2,892.27 per contract ($8,676.81 total) or for $28.92 per share. Thus, my net cost per share was $7.66 ($36.58 – $28.92 = $7.66).

Now let’s take a look at the investment values as of this writing:

If you look at the above numbers you will see that the $10,072.99 that I invested into the 3 Call Contracts (300 shares) is now showing a profit of $772.01 or 7.04% more than what I paid for them.

As for the money I was paid to sell the 3 Put Contracts (300 shares) – a total of $8,676.81 – I could buy them back today for a total cash outlay of $6,630 and pocket the difference of $2,046.81 or a return of 23.59%.

The way it stands now, my total net cost was $2,296.18 ($10,972.99 – $8,676.01) – and – my total net position value stands at $5,115 ($11,745.00 – $6,630.00) for a total net gain of $2,818.82 ($5,115.00 – $2,296.18).

So, my actual gain as it stands right now would be the profit divided by the cost (or $2,818.82 / $2,296.18 = 1.2276 x 100 = 122.76%).

Now I ask you, what makes more sense … tying up $77,166 of capital for a 2 month profit of 6.25% (which really is not bad for a stock investment these days) or tying up $2,296.18 of capital for a two month profit of 122.76%?

What happens if MSFT keeps going higher?

The Call Options will continue to grow with no limit on the gains. The Put Options will continue to fall, and can go to $0.00 which means I will keep the $8,676.01 that I was paid to sell them. So, while the gains on the Call Options are unlimited the gains on the Put Options are limited to what I was paid to sell them.

What happens if MSFT starts going lower and I don’t close the trade?

The Call Options could go to $0.00, but the Put Options would increase in value. If the stock were to drop below the strike price $265 per share the “Put Buyer” could put the stock to me at that price. However, since he paid me $28.92 to sell him/her those options he/she would likely wait till the stock fell to that much below $265 per share (or to $236.08 per share – the break-even for them) before putting the stock to me. Of course if things are not looking good and the reason for the stock falling was something happening and Microsoft to hinder it’s growth – I could always close the position before the stock was put to me.

The expiration date:

Please notice on these options I used an expiration date of 01/24/2024 which at the time of putting on this trade gave me 411 days for the options to work in my favor. It is important that if you are going to do this type of trade that you always put time on your side. You don’t necessarily need to go more than a year out … but I would recommend you consider 6 months or more.

Final advice/education:

Check with your financial advisor when you think you may want to do this kind of trade. If you don’t have a financial advisor then by all means, paper trade a few of these synthetic stocks first. If you have questions, please let me know.

Until next time, I’m signing off,

Jerry Nix | FreeWaveMaker, LLC