40 lines
1.9 KiB
Plaintext
40 lines
1.9 KiB
Plaintext
Chapter 2: Covered Call Writing
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FIGURE 2-3.
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Comparison: original covered write vs. rolled-down write.
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+$500
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c: +$300
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0
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~
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]-
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iii
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en en
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0 ...J
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5
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-e a.
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$0
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Original Write
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Rolled-Down Write
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50
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Stock Price at Expiration
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73
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profit potential of the covered write. Limiting the maximum profit may be a second
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ary consideration, however, when a stock is breaking downward. Additional downside
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protection is often a more pressing criterion in that case.
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Anywhere below 45 at expiration, the rolled-down position does $300 better
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than the original position, because of the $300 credit generated from rolling down.
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In fact, the rolled-down position will outperform the original position even if the
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stock rallies back to, but not above, a price of 48. At 48 at expiration, the two posi
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tions are equal, both producing a $300 profit. If the stock should reverse direction
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and rally back above 48 by expiration, the writer would have been better off not to
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have rolled down. All these facts are clear from Table 2-21 and Figure 2-3.
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Consequently, the only case in which it does not pay to roll down is the one in
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which the stock experiences a reversal - a rise in price after the initial drop. The
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selection of where to roll down is important, because rolling down too early or at an
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inappropriate price could limit the returns. Technical support levels of the stock are
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often useful in selecting prices at which to roll down. If one rolls down after techni
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cal support has been broken, the chances of being caught in a stock-price-reversal
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situation would normally be reduced.
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The above example is rather simplistic; in actual practice, more complicated sit
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uations may arise, such as a sudden and fairly steep decline in price by the underly
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ing stock. This may present the writer with what is called a locked-in loss. This means,
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simply, that there is no option to which the writer can roll down that will provide him |