37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
Cl,opter 4: Other Call Buying Strategies 125
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This is a relatively small percentage risk in a position that could have very large prof
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its. There is also very little chance that the entire maximum loss would ever be real
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ized since it occurs only at one specific stock price. One should not be deluded into
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thinking that this strategy is a sure money-maker. In general, stocks do not move very
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far in a 3- or 6-month period. With careful selection, though, one can often find sit
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uations in which the stock will be able to move far enough to reach the break-even
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points. Even when losses are taken, they are counterbalanced by the fact that signif
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icant gains can be realized when the stock moves by a great distance.
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It is obvious from the information above that profits are made if the stock moves
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far enough in either direction. In fact, one can determine exactly the prices beyond
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which the stock would have to move by expiration in order for profits to result. These
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prices are 34 and 46 in the foregoing example. The downside break-even point is 34
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and the upside break-:even point is 46. These break-even points can easily be com
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puted. First, the maximum risk is computed. Then the break-even points are deter
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mined.
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Maximum risk = Striking price + 2 x Call price - Stock price
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Upside break-even point = Striking price + Maximum risk
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Downside break-even point = Striking price - Maximum risk
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In the preceding example, the striking price was 40, the stock price was also 40,
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and the call price was 3. Thus, the maximum risk = 40 + 2 x 3 - 40 = 6. This con
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firms that the maximum risk in the position is 6 points, or $600. The upside break
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even point is then 40 + 6, or 46, and the downside break-even point is 40 - 6, or 34.
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These also agree with Table 4-2 and Figure 4-2.
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Before expiration, profits can be made even closer to the striking price, because
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there will be some time value premium left in the purchased calls.
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Example: IfXYZ moved to 45 in one month, each call might be worth 6. If this hap
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pened, the investor would have a 5-point loss on the stock, but would also have a 3-
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point gain on each of the two options, for a net overall gain of 1 point, or $100. Before
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expiration, the break-even point is clearly somewhere below 46, because the position
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is at a profit at 45.
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Ideally, one would like to find relatively underpriced calls on a fairly volatile
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stock in order to implement this strategy most effectively. These situations, while not
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prevalent, can be found. Normally, call premiums quite accurately reflect the volatil
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ity of the underlying stock. Still, this strategy can be quite viable, because nearly
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every stock, regardless of its volatility, occasionally experiences a straight-line, fairly
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large move. It is during these times that the investor can profit from this strategy. |