40 lines
3.1 KiB
Plaintext
40 lines
3.1 KiB
Plaintext
80 Part II: Call Option Strategies
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points from the July 60 - less the 11 points he paid to buy back the July 50. Thus, his
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option profits would amount to 2 points, which, added to the stock profit of 10 points,
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increases his maximum profit potential to 12 points anywhere above 60 at July expi
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ration.
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To increase his profit potential by such a large amount, the covered writer has
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given up some of his downside protection. The downside break-even point is always
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raised by the anwunt of the debit required to roll up. The debit required to roll up in
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this example is 4 points - buy the July 50 at 11 and sell the July 60 at 7. Thus, the
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break-even point is increased from the original 44 level to 48 after rolling up. There
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is another method of calculating the new profit potential and break-even point. In
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essence, the writer has raised his net stock cost to 55 by taking the realized 5-point
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loss on the July 50 call. Hence, he is essentially in a covered write whereby he has
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bought stock at 55 and has sold a July 60 call for 7. When expressed in this manner,
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it may be easier to see that the break-even point is 48 and the maximum profit poten
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tial, above 60, is 12 points.
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Note that when one rolls up, there is a debit incurred. That is, the investor must
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deposit additional cash into the covered writing position. This was not the case in
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rolling down, because credits were generated. Debits are considered by many
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investors to be a seriously negative aspect of rolling up, and they therefore prefer
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never to roll up for debits. Although the debit required to roll up may not be a neg
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ative aspect to every investor, it does translate directly into the fact that the break
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even point is raised and the writer is subjecting himself to a potential loss if the stock
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should pull back. It is often advantageous to roll to a more distant expiration when
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rolling up. This will reduce the debit required.
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The rolled-up position has a break-even point of 48. Thus, if XYZ falls back to
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48, the writer who rolled up will be left with no profit. However, if he had not rolled
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up, he would have made 4 points with XYZ at 48 at expiration in the original position.
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A further comparison can be made between the original position and the rolled-up
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position. The two are equal at July expiration at a stock price of 54; both have a prof
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it of 6 points with XYZ at 54 at July expiration. Thus, although it may appear attrac
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tive to roll up, one should determine the point at which the rolled-up position and
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the original position will be equal at expiration. If the writer believes XYZ could be
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subject to a 10% correction by expiration from 60 to 54 - certainly not out of the
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question for any stock - he should stay with his original position.
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Figure 2-5 compares the original position with the rolled-up position. Note that
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the break-even point has moved up from 44 to 48; the maximum profit potential has
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increased from 6 points to 12 points; and at expiration the two writes are equal, at 54.
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In summary, it can be said that rolling up increases one's profit potential but also
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exposes one to risk of loss if a stock price reversal should occur. Therefore, an ele- |