One of the ways I have discussed working from how was trading stocks. This could be day or swing trading. I have a page on it that you should look at before deciding this is right for you.
As part of that strategy I wanted to discuss one way you can purchase a stock (or a stock position to be more accurate) for next to nothing as compared to the stock value.
What are the advantages in this method?
- You can purchase stock for a small fraction of what they are worth.
- You get to take advantages of an increase in the stock price almost just like you owned it.
- You lose money just like you purchased the stock.
- You might have to watch out for time decay, but it should both help and hurt you close to equally.
I am going to use Amazon (AMZN) as my example. Right now if you wanted to buy a 100 shares of AMZN which is trading at $978.31 it would cost you $97,831.00. Who could afford that?
But, you want it. You just know it is about to go up. So what do you do? That is where a synthetic stock position comes into play using options.
Instead of paying $97,831.00 you could just purchase a near the money or at the money call and sell a near the money or at the money put. Using this strategy you would be long a call and short a put. If the stock goes up you take advantage of the increase … but if it goes down you take the losses. With Amazon trading at $978.31 your gains or losses could be substantial, but not much different than if you actually purchased the stock.
So, what is the investment difference for you?
As I said before if you bought the stock you would have to invest $97,831.00.
However you could purchase a call at $975 with about a month left on it for $3,206.00. Still a lot but I lower it even more.
At the same time sell a put at $975 for $3,035.00. Doing this would give you a total investment in Amazon of $3,206.00 – $3,035.00 or $171.00.
Using this synthetic strategy you control 100 shares of Amazon for $171.00 instead of $97,831.00.
If Amazon goes up $5.00 you could make $500.00.
If you bought the stock your return would be $500.00/$97,831.00 or .51%. Not a great return on investment.
If you purchased the synthetic stock your return would be $500.00/$171.00 or 292.40%. Now that is a GREAT return.
But remember, you can lose money just like you owned the stock also. This is a great way to increase your investment return but not any safer than purchasing the stock itself.
To be fair, I almost NEVER use this strategy. The risk is to high for me. There are better options strategies out there that have limited and defined risk. Some have unlimited upside, some don’t. Either way I prefer those to a synthetic stock strategy.
If I were to use it I would probably lean to less volatile stocks than AMZN.
Invest with caution and make sure you understand how options work.