36 lines
2.8 KiB
Plaintext
36 lines
2.8 KiB
Plaintext
Cl,apter 4: Other Call Buying Strategies 127
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above 40, the resulting profits there would be smaller because the investor would be
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long only one call instead of two.
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Example 2: XYZ has moved up to a price at which the calls are each worth 8 points.
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One of the calls could then be sold, realizing a 5-point profit. The resulting position
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would be short 100 shares of stock and long one call, a protected short sale. The pro
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tected short sale has a limited risk, above 40, of 3 points (the stock was sold short at
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40 and the call was purchased for 3 points). Even if XYZ remains above 40 and the
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maximum 3-point loss has to be taken, the overall reverse hedge would still have
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made a profit of 2 points because of the 5-point profit taken on the one call.
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Conversely, if XYZ drops below 40, the protected short sale position could add to the
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profits already taken on the call.
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There is a variation of this upside protective action.
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Example 3: Instead of selling the one call, one could instead short an additional 100
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shares of stock at 48. If this was done, the overall position would be short 200 shares
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of stock (100 at 40 and the other 100 at 48) and long two calls - again a protected
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short sale. If XYZ remained above 40, there would again be an overall gain of 2
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points. To see this, suppose that XYZ was above 40 at expiration and the two calls
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were exercised to buy 200 shares of stock at 40. This would result in an 8-point prof
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it on the 100 shares sold short at 48, and no gain or loss on the 100 shares sold short
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at 40. The initial call cost of 6 points would be lost. Thus, the overall position would
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profit by 2 points. This means of follow-up action to the upside is more costly in com
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missions, but would provide bigger profits if XYZ fell back below 40, because there
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are 200 shares of XYZ short.
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In theory, if any of the foregoing types of follow-up action were taken and the
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underlying stock did indeed reverse direction and cross back through the striking
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price, the original position could again be established. Suppose that, after covering
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the short stock at 32, XYZ rallied back to 40. Then XYZ could be sold short again,
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reestablishing the original position. If the stock moved outside the break-even points
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again, further follow-up action could be taken. This process could theoretically be
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repeated a number of times. If the stock continued to whipsaw back and forth in a
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trading range, the repeated follow-up actions could produce potentially large profits
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on a small net change in the stock price. In actual practice, it is unlikely that one
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would be fortunate enough to find a stock that moved that far that quickly.
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The disadvantage of applying these follow-up strategies is obvious: One can
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never make a large profit if he continually cuts his profits off at a small, limited |