How to own 100 shares for low cost

Today let me share with you a options strategy on how to own 100 shares for very little cost.

Suppose if you think interest rates will be coming down soon, then bond prices will rise. One way to go bullish on bonds is to trade the iShares 20yr+ ETF ($iShares 20+ Year Treasury Bond ETF(TLT)$ ). 

As of Thursday August 22, TLT last closing price was $97.75. To buy 100 shares, it will cost $97.75 x 100 = $9,775. For some traders, that is a huge cost of investment. 

Let me show you a more cost effective way instead, using a bullish synthetic option strategy. A bullish synthetic option spread involves buying a call option and selling a put option at the same strike price and expiration date. This option trade is equivalent to owning a 100 shares of the underlying, and this should only be taken if the trader understands how options work and the risk of options. 

Going to the option chain, I usually select around 30-60 days to expiration. In this case I will pick the 3rd Friday of October, expiring on Oct 18. Monthly options which expire on the third Friday of the month have higher option open interest and better bid-ask spreads compared to weekly options.

For the long call, I will select a strike that is at the money (ATM). 

• Buy Call Strike $97 @ $2.73 (bid) DEBIT

At the same time, I will sell a put at the same strike

• Sell Put Strike $97 @ $1.83 (ask) CREDIT

Total cost of the 2 leg options is:

$2.73 - $1.83 = $0.90 per contract.

Hence for 1 contract, it will cost $90.

The profit & loss profile of a bullish synthetic option spread is such that for every $1 rise in TLT, your option value will increase by $100, and on the downside, every $1 drop will result in decrease of $100 of your option value.

Hence the cost of trading the bullish synthetic at a cost of $90 is significantly lower than owning 100 TLT for $9,775. 

Options Management Strategy 

Now the trader has the following:

+1 TLT Oct18 $97 Call

-1 TLT Oct18 $97 Put

So when you are short on a put, there is a risk that if the price of TLT drops below $97, you could be early assigned. To be assigned means that you need to buy 100 shares of TLT @ $97, meaning you need cash or margin of $9,700. 

Which is why I usually choose at least 1 month from expiration, as studies have shown the options that are deep in the money with less than 21 days to expiration have less time value decay, meaning that the long option holder is losing money even though his trade is profitable. As the option seller, your risk of early assignment increases if there is less than 21 days to expiration.

When will I take profit or cut loss? For loss side, depending on your risk appetite, I would risk around $200-$300 for this trade, and cut loss if price moves against me. For take profit, as there is around 2 months to expiration, I would target around $500-600. That would be a risk reward of 1:2 for this trade. Of course if you are more bullish on TLT, you can afford to wait closer to expiration before you close the trade.

To close the trade, you will need to unwind the position by:

Selling Oct18 $97 Call

Buying Oct18 $97 Put

Hope this is a useful way for you to trade TLT if you think bonds will rise when interest rates fall.