39 lines
3.1 KiB
Plaintext
39 lines
3.1 KiB
Plaintext
Chapter 2: Covered Call Writing 61
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rrwderately out-of the-rrwney covered writes will peiform better than in-the-rrwney
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writes. In falling or static markets, any covered writer, even the more aggressive one,
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will outperform the stockowner who does not write calls. The out-of-the-money cov
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ered writer has more risk in such a market than the in-the-money writer does. But in
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a rising market, the out-of-the-money covered writer will not limit his returns as much
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as the in-the-money writer will. As stated earlier, the out-of-the-money writer's per
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formance will more closely follow the performance of the underlying stock; that is, it
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will be more volatile on a quarter-by-quarter basis.
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There is merit in either philosophy. The in-the-money writes appeal to those
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investors looking to earn a relatively consistent, moderate rate of return. This is the
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total return concept. These investors are generally concerned with preservation of
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capital, thus striving for the greater levels of downside protection available from in
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the-money writes. On the other hand, some investors prefer to strive for higher
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potential returns through writing out-of-the-money calls. These more aggressive
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investors are willing to accept more downside risk in their covered writing positions
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in exchange for the possibility of higher returns should the underlying stock rise in
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price. These investors often rely on a bullish research opinion on a stock in order to
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select out-of-the-money writes.
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Although the type of covered writing strategy pursued is a matter of personal
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philosophy, it would seem that the benefits of in-the-money strategy- more consis
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tent returns and lessened risk than stock ownership will normally provide - would
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lead the portfolio manager or less aggressive investor toward this strategy. If the
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investor is interested in achieving higher returns, some of the strategies to be pre
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sented later in the book may be able to provide higher returns with less risk than can
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out-of-the-money covered writing.
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The final important consideration in selecting a covered write is the underlying
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stock itself. One does not necessarily have to be bullish on the underlying stock to
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take a covered writing position. As long as one does not foresee a potential decline in
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the underlying stock, he can feel free to establish the covered writing position. It is
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generally best if one is neutral or slightly bullish on the underlying stock. If one is
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bearish, he should not take a covered writing position on that stock, regardless of the
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levels of protection that can be obtained. An even broader statement is that one
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should not establish a covered write on a stock that he does not want to own. Some
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individual investors may have qualms about buying stock they feel is too volatile for
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them. Impartially, if the return and protection are adequate, the characteristics of the
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total position are different from those of the underlying stock. However, it is still true
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that one should not invest in positions that he considers too risky for his portfolio, nor
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should one establish a covered write just because he likes a particular stock. If the |