Who uses options ?

DawgsCanDance said:

Options are highly useful and interesting to employ in a variety of ways and are simply an exercise in math to calculate the projected impact of. Some of the theoretical use of Options is quite simple to , other relationships are more complex but are easily understandable after you think about it. To give you the idea of how you might employ them consider the following examples...

In November 2020 I believed that Energy as a group was grossly undervalued after having gone through the floor during the downturn and was one of the few asset classes that had not rebounded so I considered the impact and attractiveness of available investment vehicles and chose to invest in Exxon the stock [XON], as well XLE the Energy ETF and also the 2X leveraged ETF ERX.

Here is the scenario I considered at the time [prices and size of investment numbers employed consider the impact of size and scale for illustration purposes]:
Buy $100,000 XON Mobil Stock at 35 3/8 with a then stated dividend of 11% [would management cut the dividend as other energy co's had?]
Buy $100,000 Energy ETF XLE at 35 3/4 with a dividend of around 6% [subject to change because many energy co's were cutting the dividend]
Buy $100,000 Direxion 2X leveraged ETF ERX at 13.25 with a Dividend of around 4 3/4% subject to change

At the time I thought that the rebound price potential for XLE energy was 54 [+55%]+ dividend, and that Exxon might run to about the same price +55% and the dividend] and that the % return potential for the 2X was about 1.75X - 2X greater so upside to maybe the 25-28 range or about +100% return over some time period.

Here is the options kicker:

At the time, the relationship between puts and calls was favorable... option puts at the 35 level were 7-5 in favor of puts which meant that for a 100,000 investment in XLE or Exxon that you could sell 30 puts at the 35 price level [a commitment promise to buy 3000 shares at 35 if the buyer chose to sell you the shares at 35 later] and you could use the proceeds of sale of the puts to purchase 42 35 calls giving you the right to buy 4200 shares also at 35 before expiration. Options come with various expiration dates and premiums that vary accordingly. In this case the January 2023 would make the most sense to give the concept a longer period to grow into the desired outcome is what I was thinking.

The above illustrates that in that scenario your obligation is the same for selling 30 puts (the risk associated with the potential obligation to buy 100,000 XLE Energy or 100,000 Exxon stock so you need to reserve the un-invested funds to fulfill your potential obligation to purchase the shares via exercise later if the stock declines significantly below 35, which is exactly the same risk that you assume if you simply bought the 3000 shares].

The advantage offered by the above is that for the same downside risk associated with purchasing 100,000 of the energy stock you have acquired the upside potential of $140,000 worth of stock over the same period.

Consider the additional kicker later if the stock moves significantly higher during the holding period after your purchase and sale of the options...

say Exxon then moves from 35 to the 40-44 range. At that price level, the value of the options that you hold are now worth 4-5 times more than the value of the options you have sold so you can then sell lets say 25% of the call options [ 10 in this case ] to buy back the negative risk exposure of the 30 puts that you sold. This leaves you long 32 call options at an exercise price of 35 with no out of pocket cash invested and no further obligation to reserve funds for the potential obligation of purchase [you have now cloned your funds for additional investments in other areas
while retaining the upside of the $100,000 investment in Energy]

Hope this helps.