Investing in T-bills (Part 3)
Posted by Mark on February 13, 2024 at 11:09 | Last modified: March 18, 2024 16:33In Part 2, I wrote about investing in T-bills while buying calls (also known as “long calls”) in the same account. Today, I will review that discussion and introduce put selling (also known as “short puts” or “naked puts”).
Long calls generally increase in value with the underlying stock once the increase is enough to offset the initial premium previously described as “rent.” In that example from the sixth paragraph here), I pay $13.73/share premium to buy the calls. After 62 days, my position will be profitable if SPY stock [an ETF] has gone up more than $13.73/share and no limit exists to how profitable these may be (net the initial $13.73 premium). If SPY increases less than $13.73/share, my position loses money. If SPY does not increase at all after 62 days, then my whole investment is lost (albeit only 2.7% of the cost to buy 200 shares outright).
I can only buy as many calls as the free cash in my account will allow (self-imposed guideline: I never want to borrow brokerage funds and owe upwards of 13% interest). Buying calls decreases free cash that may be used for T-bill investing.
Aside from buying calls, another way to participate in the movement of underlying stock is to sell puts. Long (bought) puts generally gain value as the underlying stock falls and sold (short) puts generally gain value as the underlying stock rallies. Selling puts allows me to collect premium rather than paying it; this provides a margin of safety if the underlying stock falls.
As an example, rather than buying the calls previously discussed, suppose I collect the $13.73/share premium by selling the corresponding puts.
The story is now different in several ways:
- First, the premium received for put sales (vs. premium due for call purchase) increases the cash balance in my account that I can use to buy T-bills.
- Second, if SPY increases over 62 days, then I keep the $13.73/share profit (vs. having to overcome any premium paid for profitability).
- Third, $13.73/share is my maximum potential profit (vs. unlimited profit potential net premium paid for long calls).
- Fourth, if SPY decreases up to $13.73/share, then I will have to surrender up to the entire premium received after 62 days. A net loss results if SPY decreases more than $13.73 (vs. long calls that incur maximum loss if SPY goes down at all). Potential loss on the short put is nearly unlimited except for the $13.73/share premium initially received.
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I will continue next time.
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