28 lines
2.0 KiB
Plaintext
28 lines
2.0 KiB
Plaintext
190 Part II: Call Option Strategies
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will approach its maximum profit potential. This is important to understand because,
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if one is expecting a quick move down by the underlying stock, he might need to use
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a call bear spread in which the lower strike is actually somewhat deeply in-the
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money, while the upper strike is out-of-the-money. In this case, the in-the-money call
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will decline in value as the stock moves down, even if that downward move happens
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immediately. Meanwhile, the out-of-the-money long call protects against a disastrous
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upside breakout by the stock. This type of bear spread is really akin to selling a deep
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in-the-money call for its raw downside profit potential and buying an out-of-the
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money call merely as disaster insurance.
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FOLLOW-UP ACTION
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Follow-up strategies are not difficult, in general, for bear spreads. The major thing
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that the strategist must be aware of is impending assignment of the short call. If the
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short side of the spread is in-the-money and has no time premium remaining, the
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spread should be closed regardless of how much time remains until expiration. This
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disappearance of time value premium could be caused either by the stock being
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significantly above the striking price of the stock call, or by an impending dividend
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payment. In either case, the spread should be closed to avoid assignment and the
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resultant large commission costs on stock transactions. Note that the large credit
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bear spread (one established with the stock well above the lower striking price) is
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dangerous from the viewpoint of early assignment, since the time value premium
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in the call will be small to begin with.
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SUMMARY
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The call bear spread is a bearishly oriented strategy. Since the spread is a credit
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spread, requiring only a reduction in buying power but no actual layout of cash to
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establish, it is a moderately popular strategy. The bear spread using calls may not be
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the optimum type of bearish spread that is available; a bear spread using put options
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maybe. |