Jun 292014
 

I’d like to introduce a new term for an old tool: the extra-long position. It’s an option play that creates a synthetic long position. I’m sure the ideas behind this type of position is nothing new. Despite that, it doesn’t seem to be talked about very much on the popular finance sites or among financial gurus. Perhaps that’s because initiating an extra-long position would beĀ dangerous to most amateur investors. Please proceed if 1) you are willing to increase risk and 2) are able to understand your profit and loss potential before trying this idea.

Why would you want to use an extra-long position?

Extra-long positions allow you to take on a long position in a stock when you are 100% invested, just like margin would. The benefit though is that you can avoid most of the margin interest that would also come with a margin position. As with any form of leverage, it will amplify both your gains and your losses.

In addition, the position can be created using long-term options. These options can often have a delta lower than 1. That way, if the stock moved down while still far from the expiration date you would only lose a fraction of what holding the actual stock would have caused you to lose. This allows you to back out of the position before expiration with a smaller loss. Of course, you would also gain a fraction of what holding the actual stock would cause you to gain also. This wouldn’t be a problem if you were holding it until expiration, as the delta would eventually become 1.

Finally, there is an time-value premium depending on how deep-in-the-money you go. This is icing on the cake if your position did well and a band-aid if it did not.

What is an extra position?

An extra position is a way of leveraging by selling a deep-in-the-money option, thereby enabling you to use the cash generated to enter into further positions. At the same time, holding the deep-in-the-money short option position means that, adjusting for time-value, you basically hold a synthetic position in the stock. You would only want to sell the option to enter a position that you would want to be in anyway. In other words, only sell a put if you already wanted to be long the stock and a call if you already wanted to be short.

Example:

An extra-long position can be achieved by selling a deep-in-the-money put option of Yum! Brands (YUM) and using the money generated to purchase stock in McDonald’s (MCD). In doing so, you have effectively put a long position into Yum! Brands while at the same time also taking a long position in McDonald’s – all without having to borrow on margin.

Notice how both of those stocks tend to be stable and grow in the long term? Like any other way of leveraging, you’d want to be mindful of the risk of being kicked out of the positions due to volatility before your idea completes.

 Posted by at 3:22 AM

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