35 lines
2.7 KiB
Plaintext
35 lines
2.7 KiB
Plaintext
58 Part II: Call Option Strategies
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very similar when the prices differ by small amounts. This can be seen without the
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use of a table. If one pays a dime more for the stock, his investment increases by $10
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per 100 shares, or $50 total on a 500-share transaction. However, the fact that he has
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received an extra dime for the call means that the investment is reduced by $62.50.
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Thus, there is no effect on the net investment except for commissions. The commis
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sion on 500 shares at 43.10 may be slightly higher than the commission for 500 shares
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at 43. Similarly, the commission on 5 calls at 3.10 may be slightly higher than that on
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5 calls at 3. Even so, the increase in commissions would be so small that it would not
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affect the return by more than one-tenth of 1 %.
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To carry this concept to extremes may prove somewhat misleading. If one were
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to buy stock at 40½ and sell the call at ½, he would still be receiving 40 net, but sev
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eral aspects would have changed considerably. The return if exercised remains amaz
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ingly constant, but the return if unchanged and the percentage downside protection
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are reduced dramatically. If one were to buy stock at 48 and sell the call at 8 - again
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for 40 net - he would improve the return if unchanged and the percentage downside
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protection. In reality, when one places a "net" order with a brokerage firm, he nor
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mally gets an execution with prices quite close to the ones at the time the order was
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first entered. It would be a rare case, indeed, when either upside or downside
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extremes such as those mentioned here would occur in the same trading day.
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SELECTING A COVERED WRITING POSITION
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The preceding sections, in describing types of covered writes and how to compute
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returns and break-even points, have laid the groundwork for the ultimate decision
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that every covered writer must make: choosing which stock to buy and which option
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to write. This is not necessarily an easy task, because there are large numbers of
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stocks, striking prices, and expiration dates to choose from.
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Since the primary objective of covered writing for most investors is increased
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income through stock ownership, the return on investment is an important consider
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ation in determining which write to choose. However, the decision must not be made
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on the basis of return alone. More volatile stocks will offer higher returns, but they
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may also involve more risk because of their ability to fall in price quickly. Thus, the
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amount of downside protection is the other important objective of covered writing.
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Finally, the quality and technical or fundamental outlook of the underlying stock
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itself are of importance as well. The following section will help to quantify how these
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factors should be viewed by the covered writer. |