38 lines
2.8 KiB
Plaintext
38 lines
2.8 KiB
Plaintext
Chapter 7: Bull Spreads
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XYZ common, 42;
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XYZ October 40, 4; and
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XYZ October 45, 2.
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181
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The stock owner could enhance his overall position by buying one October 40 call
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and selling two October 45 calls. Note that no extra money, except commissions, is
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required for this transaction, because the credit received from selling two October
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45's is $400 and is equal to the cost of buying the October 40 call. However, mainte
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nance and equity requirements still apply, because a spread has been established.
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The resulting position does not have an uncovered, or naked, option in it. One
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of the October 45 calls that was sold is covered by the underlying stock itself. The
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other is part of a bull spread with the October 40 call. It is not particularly important
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that the resulting position is a combination of both a bull spread and a covered write.
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What is important is the profit characteristic of this new total position.
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If XYZ should continue to decline in price and be below 40 at October expira
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tion, all the calls will expire worthless, and the resulting loss to the stock owner will
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be the same (except for the option commissions spent) as if he had merely held onto
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his stock without having done any option trading.
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Since both a covered write and a bull spread are strategies with limited profit
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potential, this new position obviously must have a limited profit. If XYZ is anywhere
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above 45 at October expiration, the maximum profit will be realized. To determine
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the size of the maximum profit, assume that XYZ is at exactly 45 at expiration. In that
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case, the two short October 45's would expire worthless and the long October 40 call
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would be worth 5 points. The option trades would have resulted in a $400 profit on
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the short side ($200 from each October 45 call) plus a $100 profit on the long side,
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for a total profit of $500 from the option trades. Since the stock was originally bought
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at 48 in this example, the stock portion of the position is a $300 loss with XYZ at 45
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at expiration. The overall profit of the position is thus $500 less $300, or $200.
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For stock prices between 40 and 45 at expiration, the results are shown in
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Table 7-3 and Figure 7-2. Figure 7-2 depicts the two columns from the table labeled
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"Profit on Stock" and "Total Profit," so that one can visualize how the new total posi
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tion compares with the original stockholder's profit. Several points should be noted
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from either the graph or the table. First, the break-even point is lowered from 48 to
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44. The new total position breaks even at 44, so that only a 2-point rally by the stock
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by expiration is necessary in order to break even. The two strategies are equal at 50
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at expiration. That is, the stock would have to rally more than 8 points, from 42 to
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50, by expiration for the original stockholder's position to outperform the new posi- |