Readers' questions about what options strategy to employ usually take two forms; the first asks what will deliver the best returns for a given scenario:

Suppose I come to the conclusion that a certain stock or commodity will betrading at least 20% higher during, say, the next six months than it is now. Ilook up the option chain and see manydifferent call strikes offered that expire six or more months from now. Isthere a theory that will help me make a rationaldecision on which expiration/strike is the best? Up until now I have been going for the cheapest, mostout-of-the-money one. That probably isn't the best strategy. Many thanks again. R.R.

or people looking for alternatives to a suggested position:
Steve, How about selling puts, let's say February '04 of 320 and buy February '04 375 and finance the call. Thanks, R.B., referring to last week's column on gold and the suggested calendar spread.

Once I'm over the initial shock that someone would consider an alternative to my suggestions, I realize these great questions bring together many of the concepts discussed in previous columns. Seriously, this is a good time to emphasize that any recommendation is just one of many ways to skin a (insert your animal here).

One of the primary attractions of using options as a trading or investment tool is the flexibility they provide, essentially allowing you to create a customized position that jibes with your specific situation or prediction; there is no one right "answer." Unlike going long or short the underlying, whose success is measured in the single dimension of buy low/sell high, option positions have a multiple of inputs, such as time and volatility, which create a much more dynamic strategy.

I am going to leapfrog to R.B.'s gold-specific question and in doing so hope to address some broader strategy issues raised by R.R.

My choice of a calendar spread as the appropriate strategy was based on the thesis that gold might work higher in slow, steady fashion. I also showed my complete lack of conviction in my doubletalk about how gold could still trade back down $320 without violating the long-term trend.

The reader's suggested alternative of selling the February '04 320 put and buying the February '04 375 essentially creates a synthetic long position. Unlike the calendar spread, which uses offsetting calls positions to reduce cost and lower risk, the two pieces in the synthetic are directionally aligned, giving the position a much more bullish profile and higher risk than the calendar spread. If gold prices fall, you lose money on both pieces. In this position the short put doesn't really finance the long call but rather works in conjunction with it. A settlement between $325 and $375 next February means both the put and call are worthless.

How Long Are You?

Remember the columns on the what and how of delta? Let's compare what happens to the two different positions of delta given hypothetical price points of gold in 30 days and the impact on equity.


Feb. 375 Calendar vs. Feb. 320/375 Synthetic
Gold Price on 6/30/03 Feb. 375 Calendar Delta Feb. 320/375 SyntheticDelta
$365 0.25 0.95
$400 -0.08 0.82
$325 0.28 0.79
Source: TSC Research


Note that while the synthetic long delta remains fairly constant (meaning your profit and loss will essentially track the price of gold), the calendar spread becomes more bullish (a higher delta) as the price of the underlying falls and more bearish (the delta actually turns negative) as gold prices rise.

They're different positions, one is no better than the other. It may take time but finding the position that matches your anticipated scenario will be worth the effort. Regarding the first reader's question, if XYZ is trading at $50 and you expect it to rise to $60, you probably don't want to buy a call with a strike any higher than the anticipated 20% move. Any strike above $60 will presumably still be out of the money and therefore worthless come expiration. This doesn't mean you won't have the opportunity during the next six months to reap a profit from out-of the-money calls.

As a segue to last week's subject of shorting bond ETF's, some readers suggested that simply selling deep in the calls as a proxy for shorting the underlying shares. This a great alternative, but again, check the delta to understand just "how short" you will be given a specific strike and expiration date.

Thanks to everyone who responded to the question regarding their attempts to borrow and short shares of these ETF products. Of the 112 responses, 86 people claimed to have no trouble shorting TLT. While the experiences were all over the map, a few points could be gleaned. The dollar amount in one's account had little to do with the ability to borrow shares. One gentleman with just $5,000 in his Ameritrade account was able to short 100 shares on his first order entry. But more money didn't necessarily translate into being able to short more stock. People with close to $1 million in accounts at a variety of online firms were limited to selling 500 shares on any given day.

The other main lesson learned is that the squeaky wheel does indeed get the grease. A registered investment advisor (RIA) who has several managed accounts at Fidelity wrote he was unable to short shares. I wrote back letting him know that other readers with far smaller accounts at the firm had written in saying they were able to borrow the stock. The RIA placed a call to his human contact at Fidelity and quickly secured the stock loan.

Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to Steve Smith.

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