39 lines
3.1 KiB
Plaintext
39 lines
3.1 KiB
Plaintext
Cl,apter 2: Covered Call Writing 53
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the return from cash. The farther out-of-the-money that the written call is, the big
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ger the discrepancy between cash and margin returns will be when the return if exer
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cised is computed.
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As with the computation for return if exercised for a write on margin, the return
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if unchanged calculation is similar for cash and margin also. The only difference is the
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subtraction of the margin interest charges from the profit. The return if unchanged is
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also higher for a margin write, provided that there is enough option premium to com
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pensate for the margin interest charges. The return if unchanged in the cash example
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was 7.9% versus 11.4% for the margin write. In general, the farther from the strike in
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either direction - out-of-the-money or in-the-money - the less the return if
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unchanged on margin will exceed the cash return if unchanged. In fact, for deeply out
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of-the-money or deeply in-the-money calls, the return if unchanged will be higher on
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cash than on margin. Table 2-11 shows that the break-even point on margin, 40.9, is
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higher than the break-even point from a cash write, 39.8, because of the margin inter
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est charges. Again, the percent downside protection can be computed as shown in
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Table 2-12. Obviously, since the break-even point on margin is higher than that on
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cash, there is less percent downside protection in a margin covered write.
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One other point should be made regarding a covered write on margin: The bro
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kerage firm will loan you only half of the strike price amount as a maximum. Thus, it
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is not possible, for example, to buy a stock at 20, sell a deeply in-the-money call struck
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at 10 points, and trade for free. In that case, the brokerage firm would loan you only
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5 - half the amount of the strike.
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Even so, it is still possible to create a covered call write on margin that has little or
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even zero margin .requirement. For example, suppose a stock is selling at 38 and that a
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long-term LEAPS option struck at 40 is selling for 19. Then the margin requirement is
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zero! This does not mean you're getting something for free, however. True, your invest
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ment is zero, but your risk is still 19 points. Also, your broker would ask for some sort of
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minimum margin to begin with and would of course ask for maintenance margin if the
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underlying stock should fall in price. Moreover, you would be paying margin interest all
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during the life of this long-term LEAPS option position. Leverage can be a good thing or
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a bad thing, and this strategy has a great deal of leverage. So be careful if you utilize it.
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COMPOUND INTEREST
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The astute reader will have noticed that our computations of margin interest have
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been overly simplistic; the compounding effect of interest rates has been ignored.
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That is, since interest charges are normally applied to an account monthly, the
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investor will be paying interest in the later stages of a covered writing position not
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only on the original debit, but on all previous monthly interest charges. This effect is
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described in detail in a later chapter on arbitrage techniques. Briefly stated, rather |