21 lines
1.4 KiB
Plaintext
21 lines
1.4 KiB
Plaintext
EXHIBIT 1.4 Target covered call.
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The solid kinked line represents the covered call position, and the thin,
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straight dotted line represents owning the stock outright. At the expiration
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of the call option, if Target is trading below $50 per share—the strike price
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—the call expires and Isabel is left with a long position of 100 shares plus
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$1.45 per share of expired-option premium. Below the strike, the buy-write
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always outperforms simply owning the stock by the amount of the
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premium. The call premium provides limited downside protection; the stock
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Isabel owns can decline $1.45 in value to $47.97 before the trade is a loser.
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In the unlikely event the stock collapses and becomes worthless, this
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limited downside protection is not so comforting. Ultimately, Isabel has
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$47.97 per share at risk.
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The trade-off comes if Target is above $50 at expiration. Here, assignment
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will likely occur, in which case the stock will be sold. The call can be
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assigned before expiration, too, causing the stock to be called away early.
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Because the covered call involves this obligation to sell the sock at the
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strike price, upside potential is limited. In this case, Isabel’s profit potential
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is $2.03. The stock can rise from $49.42 to $50—a $0.58 profit—plus $1.45
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of option premium.
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Isabel does not want the stock to decline too much. Below $47.97, the
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trade is a loser. If the stock rises too much, the stock is sold prematurely and |