percent IV, and the May has a 23 percent IV. March is the cheapest option
by IV standards. This is not necessarily a favorable quality for a short
candidate. Bill must weigh his assessment of all relevant information and
then decide which trade is best. With this type of a strategy, the benefits of
the higher theta can outweigh the disadvantages of selling the lower IV. In
this case, Bill may actually like selling the lower IV. He may infer that the
market believes Harley-Davidson will be less volatile during this period.
So far, Bill has been focusing his efforts on the 70 strike calls. If he trades
the March 70 covered call, he will have a net delta of 0.588 per contract.
That’s the negative 0.412 delta from shorting the call plus the 1.00 delta of
the stock. His indifference point if the trade is held until expiration is
$70.85. The indifference point is the point at which Bill would be
indifferent as to whether he held only the stock or the covered call. This is
figured by adding the strike price of $70 to the 0.85 premium. This is the
effective sale price of the stock if the call is assigned. If Bill wants more
potential for upside profit, he could sell a higher strike. He would have to
sell the April or May 75, since the March 75s are a zero bid. This would
give him a higher indifference point, and the upside profits would
materialize quickly if HOG moved higher, since the covered-call deltas
would be higher with the 75 calls. The April 75 covered-call net delta is
0.796 per contract (the stock delta of 1.00 minus the 0.204 delta of the call).
The May 75 covered-call delta is 0.751.
But Bill is neutral to only slightly bullish. In this case, he’d rather have
the higher premium—high theta is more desirable than high delta in this
situation. Bill buys 1,000 shares of Harley-Davidson at $69 and sells 10
Harley-Davidson March 70 calls at 0.85.
Bill also needs to plan his exit. To exit, he must study two things: an at-
expiration diagram and his greeks. Exhibit 5.8 shows the P&(L) at
expiration of the Harley-Davidson March 70 covered call. Exhibit 5.9
shows the greeks.