36 lines
2.8 KiB
Plaintext
36 lines
2.8 KiB
Plaintext
110 Part II: Call Option Strategies
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worst of the four at expiration if XYZ remains near its current price, staying above 53
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but not rising above 63 in this example.
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The other alternative, the third one listed, is to continue to hold the October 50
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call but to sell the October 60 call against it. This would create what is known as a bull
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spread, and the tactic can be used only by traders who have a margin account and can
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meet their firm's minimum equity requirement for spreading (generally $2,000). This
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spread position has no risk, for the long side of the spread - the October 50 cost 3
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points, and the short side of the spread - the October 60 - brought in 3 points via its
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sale. Even if the underlying stock drops below 50 by expiration and all the calls expire
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worthless, the trader cannot lose anything except commissions. On the other hand, the
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maximum potential of this spread is 10 points, the difference between the striking
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prices of 50 and 60. This maximum potential would be realized if XYZ were anywhere
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above 60 at expiration, for at that time the October 50 call would be worth 10 points
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more than the October 60 call, regardless of how far above 60 the underlying stock
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had risen. This strategy will be the best peiformer of the four if XYZ remains relative
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ly unchanged, above the lower strike but not much above the higher strike by expira
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tion. It is interesting to note that this tactic is never the worst peiforrner of the four
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tactics, no matter where the stock is at expiration. For example, if XYZ drops below
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50, this strategy has no risk and is therefore better than the "do nothing" strategy. If
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XYZ rises substantially, this spread produces a profit of 10 points, which is better than
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the 6 points of profit offered by the "liquidate" strategy.
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There is no definite answer as to which of the four tactics is the best one to
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apply in a given situation. However, if a call can be sold against the currently long call
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to produce a bull spread that has little or no risk, it may often be an attractive thing
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to do. It can never tum out to be the worst decision, and it would produce the largest
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profits if XYZ does not rise substantially or fall substantially from its current levels.
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Tables 3-2 and 3-3 summarize the four alternative tactics, when a call holder has an
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unrealized profit. The four tactics, again, are:
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1. "Do nothing" - continue to hold the currently long call.
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2. "Liquidate" - sell the long call to take profits and do not reinvest.
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3. "Roll up" - sell the long call, pocket the original investment, and use the remain
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ing proceeds to purchase as many out-of-the-money calls as possible.
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4. "Spread" - create a bull spread by selling the out-of-the-money call against the
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currently profitable long call, preferably taking in at least the original cost of the
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long call. |