472 Part IV: Additional Considerations 
spreads, some naked writes and ratio calendar spreads, fewer straddles and ratio 
writes, and a few covered call writes. This theory would be somewhat difficult to apply 
in practice, because of the massive numbers of calculations involved and also because 
of the accuracy of closing price data. It was mentioned previously that a computer will 
assume that "bad" closing prices are actually attainable. By a "bad" closing price, it is 
meant that the option did not trade simultaneously with the stock later in the day, and 
that the actual market for the option is somewhat different in price than is reflected 
by the closing price for the option. A daily contract volume "screen" will help allevi­
ate this problem. For example, one may want to discard any option from his calcula­
tions if that option did not trade a predetermined, minimum number of contracts 
during the previous day. Data that give closing bids and offers for each option are 
more expensive but also more reliable, and would alleviate the problem of "bad" 
closing prices. In addition to a volume screen, another way of reducing the calcula­
tions required is to limit oneself to strategies in which one has interest, or which one 
is reasonably certain will fit in well with his investment objectives. Regardless of the 
limitations that one places upon the quantity of computations, some computer power 
is necessary to compute expected return. A sophisticated programmable calculator 
may be able to provide a real-time calculation, but could never be used to evaluate 
the entire option universe and come up with a ranking of the preferable situations 
each day. On-line computer systems are also available that can provide these types of 
calculations using up-to-the-minute prices. While real-time prices may occasionally 
be useful, it is not an absolute necessity to have them. 
One other by-product of the expected return calculation is that it could be used 
as another model for predicting the theoretical value of an option. All one would have 
to do is compute the probabilities of the stock being at each successive price above 
the striking price of the option by expiration, and sum them up. The result would be 
the theoretical option value. These data are published by some services and general­
ly give a different theoretical value than would the Black-Scholes model. The reason 
for the difference most readily lies in the inclusion of the risk-free interest rate in the 
Black-Scholes model and its omission in the expected return model. 
APPLYING THE CALCULATIONS TO STRATEGY DECISIONS 
CALL WRITING 
One method of ranking covered call writes that was described in Chapter 2 was to 
rank all the writes that provided at least a minimal acceptable level of return by their 
probability of not losing money. If one were interested in safety, he might decide to 
use this approach. Suppose he decided that he would consider any write that provid-