Using Options to Establish a Toehold Position
I was having a discussion with a friend of mine that trades derivatives and wanted to get some other opinions on this strategy, because I don't have enough experience with how the options market could react to something like this.
If an activist investor with a smaller sized fund wanted to establish a toehold position, could he make up for a lack of capital by using the following strategy: long stock, long calls, short puts. If you wrote a significant amount of puts and purchasing many calls with an exercise date 1-2 months away. These would hopefully be sold and bought at similar market prices, so the fund could do this while maintaining its cash on hand for an open market purchasing of stock leading up to the exercise date. If someone was able to buy a significant amount of calls and stock, they should be able to recognize a profit on the calls since the open market purchases should cause the stock price to rise above the exercise price. This could also allow for a fund to gain a larger chunk of the company prior to the 5% disclosure requirement, which would allow more influence over the management before they start to react to a new large shareholder.
The main thing I'm concerned about with this is the movement in the options market and if the stock would react to this as well before the open market purchases of stock took place. I also realize if the stock price declines, you would take tremendous losses.
this is pretty common. also a good starting position for a bidder interested in greenmail.
Except every time you sell a naked call or naked put you need to put up margin. So if stock is trading at $100 and you sell the $100 put you got to put up 100 shares *$100 (price per share)=$10,000 per put sold. So yes you may collect the premium of put but you just used $10,000 in capital to capture easily less than $1,000(if put is $10).
The margin you put up for the put sold call vary by broker, but this is just rough example. So theory of financing calls and buying of stock from selling puts does not work out that way as you had hoped.
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