26 lines
1.7 KiB
Plaintext
26 lines
1.7 KiB
Plaintext
Chapter 6: Ratio Call Writing 149
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covered writer has upside protection all the way to infinity; that is, he has no upside
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risk at all. This cannot be the mathematically optimum situation, because stocks
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never rise to infinity. Rather, the ratio writer is engaged in a strategy that makes its
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profits in a price range more in line with the way stocks actually behave. In fact, if
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one were to try to set up the optimum strategy, he would want it to make its most
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profits in line with the most probable outcomes for a stock's movement. Ratio writ
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ing is such a strategy.
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Figure 6-2 shows a simple probability curve for a stock's movement. It is most
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likely that a stock will remain relatively unchanged and there is very little chance that
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it will rise or fall a great distance. Now compare the results of the ratio writing strat
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egy with the graph of probable stock outcomes. Notice that the ratio write and the
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probability curve have their "peaks" in the same area; that is, the ratio write makes
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its profits in the range of most likely stock prices, because there is only a small chance
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that any stock will increase or decrease by a large amount in a fixed period of time.
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The large losses are at the edges of the graph, where the probability curve gets very
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low, approaching zero probability. It should be noted that these graphs show the prof
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it and probability at expiration. Prior to expiration, the break-even points are closer
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to the original purchase price of the stock because there will still be some time value
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premium remaining on the options that were sold.
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FIGURE 6-2.
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Stock price probability curve overlaid on profit graph of ratio
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write.
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+$1,300 Probability
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Curve
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Stock Price |