52 lines
2.5 KiB
Plaintext
52 lines
2.5 KiB
Plaintext
Chapter 2: Covered Call Writing 67
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The writer wishing to establish a covered write against XYZ common stock may like
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the protection afforded by the April 40 call, but may not find the return particularly
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attractive. He may be able to improve his return by writing April 45's against part of
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his position. Assume the writer is considering buying 1,000 shares of XYZ. Table 2-18
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compares the attributes of writing the out-of-the-money (April 45) only, or of writing
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only the in-the-money (April 40), or of writing 5 of each. The table is based on a cash
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covered write, but returns and protection would be similar for a margin write.
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Commissions are included in the figures.
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It is easily seen that the "combined" write - half of the position against the April
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40's and the other half against the April 45's - offers the best balance of return and
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protection. The in-the-money call, by itself, provides over 10% downside protection,
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but the 5% return if exercised is less than 1 % per month. Thus, one might not want
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to write April 40's against his entire position, because the potential return is small. At
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the same time, the April 45's, if written against the entire stock position, would pro
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vide for an attractive return if exercised (over 2% per month) but offer only 5% down
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side protection. The combined write, which has the better features of both options,
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offers over 8% return if exercised (11h% per month) and affords over 8% downside
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protection. By writing both calls, the writer has potentially solved the problems inher
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ent in writing entirely out-of-the-moneys or entirely in-the-moneys. The "combined"
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write frees the covered writer from having to initially take a bearish (in-the-money
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write) or bullish (out-of-the-money write) posture on the stock ifhe does not want to.
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This is often necessary on a low-volatility stock trading between striking prices.
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TABLE 2-18.
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Attributes of various writes.
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Buy 1,000 XYZ and sell
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Return if exercised
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Re~rn if unchanged
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Percent protection
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In-the-Money
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Write
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10 April 40's
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5.1%
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5.1%
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10.5%
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Out-of-the-Money
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Write
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l O April 45's
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12.2%
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6.0%
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5.7%
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Write
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Both Calls
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5 April 40's and
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5 April 45's
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8.4%
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5.4%
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8.1%
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For those who prefer a graphic representation, the profit graph shown in Figure
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2-2 compares the combined write of both calls with either the in-the-money write or
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the out-of-the-money write (dashed lines). It can be observed that all three choices
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are equal if XYZ is near 42 at expiration; all three lines intersect there. |