38 lines
2.7 KiB
Plaintext
38 lines
2.7 KiB
Plaintext
280 Part Ill: Put Option Strategies
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apiece. Thus, the protection would have cost nothing and there would still be unlim
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ited profit potential on 500 of the shares of XYZ, since only five calls were sold against
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the 1000 shares that are owned.
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In this manner, one could get quite creative in constructing collars - deciding
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what call strike to use in order to strike a balance between paying for the puts and
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allowing upside profit potential. The lower the strike he uses for the written calls, the
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fewer calls he will have to write; the higher the strike of the written calls, the more
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calls will be necessary to cover the cost of the purchased puts. The tradeoff is that a
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lower call strike allows for more eventual upside profit potential, but it limits what
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has been written against to a lower price.
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Using the above example once again, these facts can be demonstrated:
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Example (continued): As before, the same prices exist, but now one more call will
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be brought into the picture:
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XYZ: 61
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Apr55 put: l
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Apr 65 call: 2
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Apr 70 call: l
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As before one could sell five of the Apr 65 calls to cover the cost of ten puts, or
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as an alternative he could sell ten of the Apr 70 calls. If he sells the five, he has unlim
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ited profit potential on 500 shares, but the other 500 shares will be called away at 65.
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In the alternative strategy, he has limited upside profit potential, but nothing will be
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called away until the stock reaches 70. Which is "better?" It's not easy to say. In the
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former strategy, if the stock climbs all the way to 75, it results in the same profit as if
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the stock is called away at 70 in the latter strategy. This is true because 500 shares
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would be worth 75, but the other 500 would have been called away at 65 - making
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for an average of 70. Hence, the former strategy only outperforms the latter if the
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stock actually climbs above 75 - a rather unlikely event, one would have to surmise.
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Still, many investors prefer the former strategy because it gives them protection with
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out asking them to surrender all of their upside profit potential.
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In summary, one can often be quite creative with the "collar" strategy. One thing
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to keep in mind: if one sells options against stock that he has no intention of selling, he
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is actually writing naked calls in his ovm mind. That is, if one owns stock that "can't"
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be sold - perhaps the capital gains would be devastating or the stock has been "in the
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family" for a long time - then he should not sell covered calls against it, because he will
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be forced into treating the calls as naked (if he refuses to sell the stock). This can cause
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quite a bit of consternation if the underlying stock rises significantly in price, that could
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have easily been avoided by not writing calls against the stock in the first place. |