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Peter D » Comments » BUCY
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Bucyrus: Significantly Undervalued [View article]
Your answer left me speechless. Your cash-on-cash return calculation is incorrect, even if we have other paid up equity positions in the account. The risk is that people could get into the Margin Call using these trades with the naked short PUT.
For example, if BUCY drops to $5 in the next two months, then the Jan 2010 $20 PUT would be worth approximately $17 ($15 intrinsic and at least $2 extrinsic). The margin requirement is suddenly $17 plus 20% of stock price of $5 = $18. We got $7.6 credit when sold the naked PUT, and now needs the extra $10.4 in the account as margin/collateral. If we don't have the extra cash, we'll get a Margin Call. Even if BUCY bounce back to over $20, the Margin Call can hurt and force people to sell at a low.
I strongly suggest you to modify all your calculation on naked PUT for other stock recommendations to accommodate the margin requirement of the PUT. Imagine if a person acted on all your Covered Call and naked PUT strategies, they can easily get a margin call when the market drops 5-10% from here. That is dangerous and we should at least warn people on the risk.
Bucyrus: Significantly Undervalued [View article]
Thanks for the very good article. I think you've forgot to include the margin requirement for the naked PUT sold. It could be up to 20% of the underlying price, plus the value of the naked PUT, i.e. typical margin requirement of 20% of $19 (stock price) plus $7.6 is about $11.4. So the cash outlay is $19,000 - $6,700 = 12,300 for the Covered Call, and $3,800 in margin for the naked PUT. The account would be credited $7,600 from the naked PUT, plus an additional $3,800 is hold as collateral. So the net cash outlay is $12,300 + $3,800 = $16,100. We can make a maximum of $14,300 from the call and put sold, which is 89%. In fact, the margin requirement for the stock is usually 33%-50%, so the profit can be higher.
One of the risk is that the naked PUT margin requirement increases as the price does down, so we might need more margin to cover this combination.