37 lines
2.6 KiB
Plaintext
37 lines
2.6 KiB
Plaintext
90 Part II: Call Option Strategies
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The writer should also be aware of whether or not the convertible is catlable
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and, if so, what the exact terms are. Once the convertible has been called by the com
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pany, it will no longer trade in relation to the underlying stock, but will instead trade
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at the call price. Thus, if the stock should climb sharply, the writer could be incur
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ring losses on his written option without any corresponding benefit from his con
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vertible security. Consequently, if the convertible is called, the entire position should
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normally be closed immediately by selling the convertible and buying the option
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back.
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Other aspects of covered writing, such as rolling down or forward, do not
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change even if the option is written against a convertible security. One would take
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action based on the relationship of the option price and the common stock price, as
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usual.
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WRITING AGAINST WARRANTS
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It is also possible to write covered call options against warrants. Again, one must own
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enough warrants to convert into 100 shares of the underlying stock; generally, this
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would be 100 warrants. The transaction must be a cash transaction, the warrants
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must be paid for in full, and they have no loan value. Technically, listed warrants may
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be marginable, but many brokerage houses still require payment in full. There may
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be an additional investment requirement. Warrants also have an exercise price. If the
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exercise price of the warrant is higher than the striking price of the call, the covered
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writer must also deposit the difference between the two as part of his investment.
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The advantage of using warrants is that, if they are deeply in-the-money, they
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may provide the cash covered writer with a higher return, since less of an investment
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is involved.
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Example: XYZ is at 50 and there are XYZ warrants to buy the common at 25. Since
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the warrant is so deeply in-the-money, it will be selling for approximately $25 per
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warrant. XYZ pays no dividend. Thus, if the writer were considering a covered write
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of the XYZ July 50, he might choose to use the warrant instead of the common, since
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his investment, per 100 shares of common, would only be $2,500 instead of the
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$5,000 required to buy 100 XYZ. The potential profit would be the same in either
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case because no dividend is involved.
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Even if the stock does pay a dividend (warrants themselves have no dividend),
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the writer may still be able to earn a higher return by writing against the warrant than
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against the common because of the smaller investment involved. This would depend,
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of course, on the exact size of the dividend and on how deeply the warrant is in-the
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money. |