40 lines
3.2 KiB
Plaintext
40 lines
3.2 KiB
Plaintext
Cl,apter 5: Naked Call Writing 141
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In essence, the writer who is rollingf or credits sells the most time premium that
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he can at any point in time. This would generally be the longest-term, at-the-money
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call. If the stock declines, the writer makes the time premium that he sold. However,
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if the stock rises in price, the writer rolls up for a credit. That is, when the stock
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reaches the next higher striking price, the writer buys back the calls that were origi
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nally sold and sells enough long-term calls at the higher strike to generate a credit.
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In this way, no debits are incurred, although a realized loss is taken on the rolling up.
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If the stock persists and rises to the next striking price, the process is repeated.
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Eventually, the stock will stop rising - they always do - and the last set of written
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options will expire worthless. At that time, the writer would make an overall profit
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consisting of an amount equal to all the credits that he had taken in so far. In reality,
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most of that credit will simply be the initial credit received. The "rolls" are done for
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even money or a small credit. In essence, the increased risk generated by continual
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ly rolling up is all geared toward eventually capturing that initial credit. The similar
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ity to the Martingale strategy is strongest in this regard: One continually increases his
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risk, knowing that when he eventually wins (i.e., the last set of options expires worth
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less), he profits by the amount of his original "bet."
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There are really only two requirements for success in this strategy. The first is
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that the underlying stock eventually fall back, that it does not rise indefinitely. This is
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hardly a requirement; it is axiomatic that all stocks will eventually undergo a correc
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tion, so this is a simple requirement to satisfy. The second requirement is that the
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investor have enough collateral backing to stay with the strategy even if the stock runs
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up heavily against him.
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This is a much harder requirement to satisfy, and may in fact tum out to be
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nearly impossible to satisfy. If the stock were to experience a straight-line upward
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move, the number of calls written might grow so substantially that they would
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require an unrealistically large amount of collateral (margin). At a minimum, this
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strategy is applicable only for the largest investors. For such well-collateralized
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investors, this strategy can be thought of as a way to add income to a portfolio. That
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is, a large stock portfolio's equity may be used to finance this strategy through its loan
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value. There would be no margin interest charges, because all transactions are cred
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it transactions. (No debits are created, as long as the Martingale "limits" are not
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reached.) The securities portfolio would not have to be touched unless the strategy
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were terminated before the last set of calls expired worthless.
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This is where the danger comes in: If the stock upon which the calls are written
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rises so fast that one completely uses up all of his collateral value to finance the naked
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calls, and then one is required to roll again, the strategy could result in large losses.
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For a while, one could simply continue to roll the same number of calls up for deb
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its, but eventually those debits would mount in size if the stock persisted in rising. At |