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training_data/relevant/text/6c929316aa6a24176c4213ff0d968d1a54290ab48da3dc4dcbc625172b1ed53f.txt

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+276 Part Ill: Put Option Strategies 
+The purchase of an out-of the-money put option can eliminate the risk of large 
+potential losses for the covered write, although the money spent for the put purchase 
+will reduce the overall return from the covered write. One must therefore include 
+the put cost in his initial calculations to determine if it is worthwhile to buy the put. 
+Example: X'YZ is at 39 and there is an XYZ October 40 call selling for 3 points and an 
+XYZ October 35 put selling for ½ point. A covered write could be established by buy­
+ing the common at 39 and selling the October 40 call for 3. This covered write would 
+have a maximum profit potential of 4 points if XYZ were anywhere above 40 at expi­
+ration. The write would lose money if XYZ were anywhere below 36, the break-even 
+point, at October expiration. By also purchasing the October 35 put at the time the 
+covered write is initiated, the covered writer will limit his profit potential slightly, but 
+will also greatly reduce his risk potential. If the put purchase is added to the covered 
+write, the maximum profit potential is reduced to 3½ points at October expiration. The 
+break-even point moves up to 36½, and the writer will experience some loss if XYZ is 
+below 36½ at expiration. However, the most that the writer could lose would be 1 ¼ 
+points if XYZ were below 35 at expiration. The purchase of the put option produces 
+this loss-limiting effect. Table 17-2 and Figure 17-2 depict the profitability of both the 
+regular covered write and the covered write that is protected by the put purchase. 
+Commissions should be carefully included in the covered writer's return calcula­
+tions, as well as the cost of the put. It was demonstrated in Chapter 2 that the covered 
+writer must include all commissions and margin interest expenses as well as all divi­
+dends received in order to produce an accurate "total return" picture of the covered 
+write. Figure 17-2 shows that the break-even point is raised slightly and the overall prof­
+it potential is reduced by the purchase of the put. However, the maximum risk is quite 
+small and the writer need never be forced to roll down in a disadvantageous situation. 
+Recall that the covered writer who does not have the protective put in place is 
+forced to roll down in order to gain increased downside protection. Rolling down 
+merely means that he buys back the call that is currently written and writes another 
+call, with a lower striking price, in its place. This rolling-down action can be helpful 
+if the stock stabilizes after falling; but if the stock reverses and climbs upward in price 
+again, the covered writer who rolled down would have limited his gains. In fact, he 
+may even have "locked in" a loss. The writer who has the protective put need not be 
+bothered with such things. He never has to roll down, for he has a limited maximum 
+loss. Therefore, he should never get into a "locked-in" loss situation. This can be a 
+great advantage, especially from an emotional viewpoint, because the writer is never 
+forced to make a decision as to the future price of the stock in the middle of the 
+stock's decline. With the put in place, he can feel free to take no action at all, since 
+his overall loss is limited. If the stock should rally upward later, he will still be in a 
+position to make his maximum profit.