36 lines
2.4 KiB
Plaintext
36 lines
2.4 KiB
Plaintext
Cbapter 2: Covered Ca# Writing
|
||
Example: The following prices exist at January expiration:
|
||
XYZ, 50;
|
||
XYZ January 45 call, 5; and
|
||
XYZ July 50 call, 7.
|
||
85
|
||
In this case, if one had originally written the January 45 call, he could now roll up to
|
||
the July 50 at expiration for a credit of 2 points. This action is quite prudent, since
|
||
the break-even point and the maximum profit potential are enhanced. The break
|
||
even point is lowered by the 2 points of credit received from rolling up. The maxi
|
||
mum profit potential is increased substantially - by 7 points - since the striking price
|
||
is raised by 5 points and an additional 2 points of credit are taken in from the roll up.
|
||
Consequently, whenever one can roll up for a credit, a situation that would normally
|
||
arise only on more volatile stocks, he should do so.
|
||
Another choice that may occur at or near expiration is that of rolling down. The
|
||
case may arise whereby one has allowed a written call to expire worthless with the
|
||
stock more than a small distance below the striking price. The writer is then faced
|
||
with the decision of either writing a small-premium out-of-the-money call or a larg
|
||
er-premium in-the-money call. Again, an example may prove to be useful.
|
||
Example: Just after the January 25 call has expired worthless,
|
||
XYZ is at 22,
|
||
XYZ July 25 call at ¾, and
|
||
XYZ July 20 call at 3½.
|
||
If the investor were now to write the July 25 call, he would be receiving only¾ of a
|
||
point of downside protection. However, his maximum profit potential would be quite
|
||
large if XYZ could rally to 25 by expiration. On the other hand, the July 20 at 3½ is
|
||
an attractive write that affords substantial downside protection, and its 1 ½ points of
|
||
time value premium are twice that offered by the July 25 call. In a purely analytic
|
||
sense, one should not base his decision on what his performance has been to date,
|
||
but that is a difficult axiom to apply in practice. If this investor owns XYZ at a high
|
||
er price, he will almost surely opt for the July 25 call. If, however, he owns XYZ at
|
||
approximately the same price, he will have no qualms about writing the July 20 call.
|
||
There is no absolute rule that can be applied to all such situations, but one is usual
|
||
ly better off writing the call that provides the best balance between return and down
|
||
side protection at all times. Only if one is bullish on the underlying stock should he
|
||
write the July 25 call. |