38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
116 Part II: Call Option Strategies
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spread could make is now $100, less commissions. The alternative in this example is
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not nearly as attractive as the previous one, but it might still be worthwhile for the
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call buyer to invoke such a spread if he feels that XYZ has limited rally potential up
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to October expiration.
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One should not automatically discard the use of this strategy merely because a
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debit is required to convert the long call to a spread. Note that to "average down" by
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buying an additional October 35 call at 1 ½ would require an additional investment
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of $150. This is more than the $100 required to convert into the spread position in
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the immediately preceding example. The break-even point on the position that was
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"averaged down" would be over 37 at expiration, whereas the break-even point on the
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spread is 34. Admittedly, the averaged-down position has much more profit potential
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than the spread does, but the conversion to the spread is less expensive than "aver
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aging down" and also provides a lower break-even price.
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In summary, then, if the call buyer finds himself with an unrealized loss because
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the stock has declined, and yet is unwilling to sell, he may be able to improve his
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chances of breaking even by "rolling down" into a spread. That is, he would sell 2 of
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the calls that he is currently long - the one that he owns plus another one - and
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simultaneously buy one call at the next lower striking price. If this transaction of sell
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ing 2 calls and buying 1 call can be done for approximately even money, it could def
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initely be to the buyer's benefit to implement this strategy, because the break-even
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point would be lowered considerably and the buyer would have a much better
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chance of getting out even or making a small profit should the underlying stock have
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a small rebound.
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Creating a Calendar Spread. A different type of defensive spread strategy
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is sometimes used by the call buyer who finds that the underlying stock has declined.
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In this strategy, the holder of an intermediate- or long-term call sells a near-term call,
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with the same striking price as the call he already owns. This creates what is known
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as a calendar spread. The idea behind doing this is that if the short-term call expires
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worthless, the overall cost of the long call will be reduced to the buyer. Then, if the
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stock should rally, the call buyer has a better chance of making a profit.
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Example: Suppose that an investor bought an XYZ October 35 call for 3 points some
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time in April. By June the stock has fallen to 32, and it appears that the stock might
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remain depressed for a while longer. The holder of the October 35 call might con
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sider selling a July 35 call, perhaps for a price of 1 point. Should XYZ remain below
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35 until July expiration, the short call would expire worthless, earning a small, 1-point
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profit. The investor would still own the October 35 call and would then hope for a
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rally by XYZ before October in order to make profits on that call. Even if XYZ does |