42 lines
2.7 KiB
Plaintext
42 lines
2.7 KiB
Plaintext
' 64 Part II: Call Option Strategies
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month, the level nominally used for acceptable covered writes. Thus, the investor
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who already owns stock may inadvertently be overlooking a potentially attractive cov
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ered write because he has not computed the returns excluding the stock purchase
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commission on his current stock holding.
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It could conceivably be an even more extreme oversight for the investor to
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switch from XYZ to AAA for writing purposes. The investor may consider making this
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switch because he thinks that he could substantially increase his return, from 6.3% to
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9.9% for the 6-month period, as shown in Table 2-17 comparing the two writes.
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However, the returns are not truly comparable because the investor already
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owns XYZ. To make the switch, he would first have to spend $345 in stock commis
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sions to sell his XYZ, thereby reducing his profits on AAA by $345. Referring again to
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the preceding detailed breakdown of the return if exercised, the profit on AAA would
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then decline to $1,874 on the investment of $22,436, a return if exercised (cash) of
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8.4%. On margin, the comparable return from switching stocks would drop to 14.8%.
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The real comparison in returns from writing against these two stocks should be
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made in the following manner. The return from writing against XYZ that is already
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held should be compared with the return from writing against AAA after switching
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fromXYZ:
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Return if exercised - cash
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Return if exercised - margin
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XYZ Already Held
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7.9%
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11.3%
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Switch from XYZ to AAA
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8.4%
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14.8%
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Each investor must decide for himself whether it is worth this much smaller
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increase in return to switch to a more volatile stock that pays a smaller dividend. He
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can, of course, only make this decision by making the true comparison shown imme
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diately above as opposed to the first comparison, which assumed that both stocks had
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to be purchased in order to establish the covered write.
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The same logic applies in situations in which an investor has been doing cov
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ered writing. If he owns stock on which an option has expired, he will have to decide
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whether to write against the same stock again or to sell the stock and buy a new stock
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for covered writing purposes. Generally, the investor should write against the stock
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already held. This justifies the method of computation of return if unchanged for out
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of-the-money writes and also the computation of downside break-even points in
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which a stock sale commission was not charged. That is, the writer would not nor
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mally sell his stock after an option has expired worthless, but would instead write
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another option against the same stock. It is thus acceptable to make these computa
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tions without including a stock sales commission. |