Vintage Capital Advisors, LLC

As an investment advisor, one of the comments we hear in a regular basis is, “I really like this company and/or the market, but I’m not sure right now is the right time to buy.  I wish there was a way to buy it without putting too much into it right now.”  Our response to them is simple. “You can, and we have the solution.”  To illustrate the point, we will talk about an actual transaction we executed on 1/31/2011.  The stock is one which has reasonable growth prospects as the market recovers, has a good balance sheet, and has recently experienced a pullback.  The company is Las Vegas Sands (LVS) trading about $46.50 on 1/31/2011, and the strategy is a Vertical Spread used in combination with a Short Put. This strategy is a bullish strategy and creates a synthetic long position in the stock.

The way the strategy works is as follows:

1. We create a Vertical Spread on the stock by selling the June 2011 LVS $57.50 strike call option, and we simultaneously buy the June 2011 LVC $46.00 strike call option.
2. Next to cover the difference in premium on this transaction, and since we are bullish on the stock at $46.50 per share anyway, we sell the June 2011 LVS $43.00 strike put option.

So here are the real life results of this transaction:

1. Our Vertical Spread yielded us a premium by selling the call of $2.19, and our purchase of the call option cost us $5.87 per contract.  This results in a net cash outlay of $3.68 (5.87 paid – 2.19 rec’d).
2. Our Short Put yielded us a premium by selling the put option of $3.82.
3. The result of this strategy is a net premium received is $0.14 (a little better than zero cost).
4. Breakeven is the amount of our long call less our net premium received or $45.86 per share, and our risk is having to buy the stock at $43 if is drops precipitously and closes below $43 per share at expiration.

Now we are net long, for less than $0.00, through our call option at $46 and participate in the upward movement in the stock up to $57 per share where our gain is capped.  Our put option will expire worthless as the stock goes up and we keep the premium. 

Best Case:  Stock continues up and at expiration the stock is above $57 per share at expiration for a net gain of $11.14 per share ($57 - $46 - $0.14) or a net gain of 24.29% for this 6 month option strategy.

Moderate Case:  Stock closes below $57 per share, but above $46 per share at expiration.  We now own the stock, but as long as it is above our breakeven of $45.86 we are ok.

Worst Case:  Stock is below $43 per share at expiration and we are required to purchase the shares at $43 per share.  Since we are bullish on the stock at $46.50, buying it at $43 is better provided nothing fundamentally has changed with the company.

The idea behind this strategy is to participate in the upside of the company, up to the cap or of your short call, without actually putting any money into the stock.