36 lines
2.6 KiB
Plaintext
36 lines
2.6 KiB
Plaintext
Chapter 25: LEAPS 39S
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✓,,FREE" COVERED CALL WRITES
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In Chapter 2, a strategy of writing expensive LEAPS options was briefly described.
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In this section, a more detailed analysis is offered. A certain type of covered call
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write, one in which the call is quite expensive, sometimes attracts traders looking for
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a "free ride." To a certain extent, this strategy is something of a free ride. As you
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might imagine, though, there can be major problems.
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The investment required for a covered call write on margin is 50% of the stock
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price, less the proceeds received from selling the call. In theory, it is possible for an
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option to sell for more than 50% of the stock cost. This is a margin account, a cov
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ered write could be established for "free." Let's discuss this in terms of two types of
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calls: the in-the-money call write and the out-of-the-money call write.
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Out-of-the-Money Covered Call Write. This is the simplest way to approach
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the strategy. One may be able to find LEAPS options that are just slightly out-of-the
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money, which sell for 50% of the stock price. Understandably, such a stock would be
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quite volatile.
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Example: GOGO stock is selling for $38 per share. GOGO has listed options, and a
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2-year LEAPS call with a striking price of 40 is selling for $19. The requirement for
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this covered write would be zero, although some commission costs would be
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involved. The debit balance would be 19 points per share, the amount the broker
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loans you on margin.
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Certain brokerage firms might require some sort of minimum margin deposit, but
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technically there is no further requirement for this position. Of course, the leverage
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is infinite. Suppose one decided to buy 10,000 shares of GOGO and sell 100 calls,
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covered. His risk is $190,000 if the stock falls to zero! That also happens to be the
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debit balance in his account. Thus, for a minimal investment, one could lose a for
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tune. In addition, if the stock begins to fall, one's broker is going to want maintenance
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margin. He probably wouldn't let the stock slip more than a couple of points before
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asking for margin. If one owns 10,000 shares and the broker wants two points main
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tenance margin, that means the margin call would be $20,000.
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The profits wouldn't be as big as they might at first seem. The maximum gross
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profit potential is $210,000 if the 10,000 shares are called away at 40. The covered
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write makes 21 points on each share - the $40 sale price less the original cost of $19.
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However, one will have had to pay interest on the debit balance of $190,000 for two
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years. At 10%, say, that's a total of $38,000. There would also be commissions on the
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purchase and the sale. |