35 lines
2.5 KiB
Plaintext
35 lines
2.5 KiB
Plaintext
222 • The Intelligent Option Investor
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indicate on your statements that a certain proportion of your account effec-
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tively will be treated as margin. This means that you stand to receive the eco-
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nomic benefit from your diversified portfolio of securities but will not be able
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to liquidate all of it. If the market climbs higher, a larger proportion of your
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portfolio will be considered as margin; if it falls lower, a smaller proportion
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of your portfolio will be considered as margin. Basically, a proportion of any
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gains from your diversified stock portfolio will be reapportioned to serve as
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collateral for your short call when the market is rising, and a proportion of any
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losses from your diversified stock portfolio will be offset by a freeing of margin
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related to your profits on the short call when the market is falling.
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Most brokers restrict the ability of individual investors to write un-
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covered calls on individual stocks, so the rest of this discussion will cover
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the short-call spread strategy for individual stocks.
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T enor Selection
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Tenors for short-call spreads should be fairly short under the same reason-
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ing as that for short puts—one receives more time value per day for short-
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er-tenor options. Look for calls in the three- to nine-month tenor range.
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The tenor of the purchased call (at the higher strike price) should be the
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same as the tenor of the sold calls (at the lower strike price). Theoretically,
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the bought calls could be longer, but it is hard to think of a valuation justifi-
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cation for such a structure. By buying a longer-tenor call for the upside leg
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of the investment, you are expressing an investment opinion that the stock
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will likely rise over the long term—this exactly contradicts the purpose of
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this strategy: expressing a bearish investment opinion.
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Strike Price Selection
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Theoretically, you can choose any two strike prices, sell the call at the lower
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price, and buy the call at the higher price and execute this investment. If you
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sold an ITM call, you would receive premium that consists of both time and
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intrinsic value. If the stock fell by expiration, you would realize all the wasted
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time value plus the difference between the intrinsic value at initiation and the
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intrinsic value at expiration.
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Despite the theory, however, in practice, the lower strike option is usually
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sold ATM or OTM because of the threat of assignment. Assignment is the pro-
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cess the exchange goes through when investors choose to exercise the option |