126 Part II: Call Option Strategies 
Generally, the underlying stock selected for the reverse hedge should be 
volatile. Even though option premiums are larger on these stocks, they can still be 
outdistanced by a straight-line move in a volatile situation. Another advantage of uti­
lizing volatile stocks is that they generally pay little or no dividends. This is desirable 
for the reverse hedge, because the short seller will not be required to pay out as 
much. 
The technical pattern of the underlying stock can also be useful when selecting 
the position. One generally would like to have little or no technical support and 
resistance within the loss area. This pattern would facilitate the stock's ability to make 
a fairly quick move either up or down. It is sometimes possible to find a stock that is 
in a wide trading range, frequently swinging from one side of the range to the other. 
If a reverse hedge can be set up that has its loss area well within this trading range, 
the position may also be attractive. 
Example: The XYZ stock in the previous example is trading in the range 30 to 50, 
perhaps swinging to one end and then the other rather frequently. Now the reverse 
hedge example position, which would make profits above 46 or below 34, would 
appear more attractive. 
FOLLOW-UP ACTION 
Since the reverse hedge has a built-in limited loss feature, it is not necessary to take 
any follow-up action to avoid losses. The investor could quite easily put the position 
on and take no action at all until expiration. This is often the best method of follow­
up action in this strategy. 
Another follow-up strategy can be applied, although it has some disadvantages 
associated with it. This follow-up strategy is sometimes known as trading against the 
straddle. When the stock moves far enough in either direction, the profit on that side 
can be taken. Then, if the stock swings back in the opposite direction, a profit can 
also be made on the other side. Two examples \vill show how this type of follow-up 
strategy works. 
Example 1: The XYZ stock in the previous example quickly moves down to 32. At 
that time, an 8-point profit could be taken on the short sale. This would leave two 
long calls. Even if they expired worthless, a 6-point loss is all that would be incurred 
on the calls. Thus, the entire strategy would still have produced a profit of 2 points. 
However, if the stock should rally above 40, profits could be made on the calls as well. 
A slight variation would be to sell one of the calls at the same time the stock profit is 
taken. This would result in a slightly larger realized profit; but if the stock rallied back