50 lines
2.0 KiB
Plaintext
50 lines
2.0 KiB
Plaintext
Accepting Exposure • 229
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×= ≈$19,500
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$5,000 13 .9 4: 1leverage
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Selling the $195/$220 call spread will generate $651 worth of pre-
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mium income and put at risk $2,500 worth of capital. Nothing can change
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these two numbers—in this sense, the short-call spread has no leverage.
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The 4:1 leverage figure merely means that the percentage return will ap-
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pear nearly four times as large on a given allocation as a 1:1 allocation
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would appear. The following table—assuming the sale of one contract of
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the $195/$220 call spread—shows this in detail:
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Winning Case Losing Case
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Premium
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Received
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($)
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Target
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Allocation
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($) Leverage
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Stock
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Move ($)
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Percent
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Return on
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Allocation
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Stock
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Move
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($)
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Dollar
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Return
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Percent
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Return on
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Allocation
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651 20,000 1:1 –2 3.3 +25 –1,849 –9.2
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651 10,000 2:1 –2 6.5 +25 –1,849 –18.5
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651 5,000 4:1 –2 13.0 +25 –1,849 –37.0
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Note: The dollar return in the losing case is calculated as the loss of the $2,500 of margin
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per contract less than the premium received of $651.
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Notice that the premium received never changes, nor does the worst-
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case return. Only the perception of the loss changes with the size of our
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target allocation.
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Now that we have a sense of how to calculate what strategic leverage
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we are using, let’s think about how to size the position and about how much
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risk we are willing to take. When we are selling a call or call spread, we are
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committing to sell a stock at the strike price. If we were actually selling the
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stock at that price rather than committing to do so, where would we put
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our stop loss—in other words, when would we close the position, assuming
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that our valuation or our timing was not correct?
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Let’s say that for this stock, if the price rose to $250, you would be
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willing to admit that you were wrong and would realize a loss of $55 per share,
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or $5,500 per hundred shares. This figure—the $5,500 per hundred shares
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you would be willing to lose in an unlevered short stock position—can be
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used as a guide to select the size of your levered short-call spread. |