| Options/Selling Short Question |
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Knocka
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| Options/Selling Short Question |
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In Cramer's new book, he recommends a strategy where you buy an in the money call, and then, if you want to close out the position after a gain, you sell the stock short rather than sell the call. In this way, the profit is locked in since if the stock than goes down, you are making money on the short sale of the stock. (Obviously, if you bought 1 call, you would sell 100 shares of the stock short).
I understand all of the above.
BUT, Cramer says to use a second account for the short sales. Thus, you would have two investment accounts, one to buy the calls, and one to sell the stock short.
I cannot understand why two accounts are necessary. Why couldn't you just sell the stock short in the same account in which you own the calls?
Thanks.
Knocka
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Tue Dec 01, 2009 11:21 am |
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Knocka
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Thanks for the response. The purpose of selling the shares short, as I understand it, is to lock in the gain on the calls without selling the calls. By doing this, you get a "free" insurance policy on the shares going down. Or put another way, you get to short the stock for nothing, at no risk. If the stock goes up, you lose on the short but can exercise the calls and cover the short position. If the shares go down, you "lose" on the calls, but make the money back on the short.
I understand about option pricing and the risks in options. None of this is intended to reduce or eliminate those issues. Rather, this strategy is simply a different way of closing the position on the calls after a gain that you are satisfied with. The idea is, if you were going to sell the calls anyway and close the position, thus stopping your upside, why not sell a like number of shares short instead, giving yourself a risk free short position.
I am not entirely clear, though, as to why two accounts are necessary.
Knocka
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Tue Dec 01, 2009 5:58 pm |
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Raptor
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They essentially cancel each other out. Don't think that my broker would allow me to take such a position. Why not just sell the call and cash in the profit. If you think the stock is going to go down then additionally sell short. I really don't understand how you can make any additional money with two positions that cancel each other out.
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Tue Dec 01, 2009 10:09 pm |
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Raptor
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Agreed, I'm not a Cramer fan. Seems to be an interesting idea to fill a chapter in a book, but the practicality of the idea to increase additional gains seems short.
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Tue Dec 01, 2009 10:16 pm |
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Knocka
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In order to do this, you buy in the money calls. Assuming the trade is successful and the stock goes up, you then "close" the position by selling the shares short. At this point, you are correct that the trades essentially cancel each other out because if the stock goes higher, you lose on the short sale but gain what should be an equivalent amount on the call since the call will move $1.00 for $1.00 with the stock when it is in the money (I am actually not sure this is true unless the calls are deep in the money). But basically, these two trades should be, according to Cramer, mirror images.
But, if the stock plummets, maybe because of some unforeseen event, you can make even more on the short sale. In that event, you realize the profit on the short sale and even if the call expires worthless, you are ahead.
Again, according to Cramer (if I understand him correctly), if you buy an in the money call, and the trade works and the stock rises as expected, you can lock in that gain by selling the shares short. While a plummet in the stock may not be likely, there is no risk to doing this because, as stated above, the trades are mirror images of each other. It is only in the event of a substantial decline in the stock, that the short pays off.
I basically understand this, but what I still don't completely understand is why the necessity of two separate accounts unless, as stated in an earlier post, trading rules prohibit being long the call and short the stock in the same account.
Knocka
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Wed Dec 02, 2009 2:31 am |
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oldguy
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Why short the stock? Wouldn't it be less expensive to buy 'in the money puts' to mirror your 'calls'? Ie, use the straddle to protect your gains?
I don't know why Kramer suggests two accounts - I have traded puts, calls, sold covered calls, and owned corn futures - all in a single brokerage account. Unless my broker somehow segregated them internally and I didn't know about it.
I've occasionally watched Kramer - I'm afraid he is going to turn bright red and have a stroke right in the miidle of his Show - he sure does get ito his work doesn't he?
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Wed Dec 02, 2009 3:32 am |
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lancenicolase
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options are not that straight forward.
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Thu Dec 02, 2021 6:07 pm |
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