35 lines
2.8 KiB
Plaintext
35 lines
2.8 KiB
Plaintext
122 Part II: Call Option Strategies
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FOLLOW-UP ACTION
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There is little that the protected short seller needs to perform in the way of follow
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up action in this strategy, other than closing out the position. If the underlying stock
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moves down quickly and it appears that it might rebound, the short sale could be cov
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ered without selling the long call. In this manner, one could potentially profit on the
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call side as well if the stock came back above the original striking price. If the under
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lying stock rises in price, a similar strategy of taking off only the profitable call side
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of the transaction is not recommended. That is, if XYZ climbed from 40 to 50 and the
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July 40 call also rose from 3 to 10, it is not advisable to take the 7-point profit in the
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call, hoping for a drop in the stock price. The reason for this is that one is entering
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into a highly risk-oriented situation by removing his protection when the call is in
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the-money. Thus, when the stock drops, it is all right - perhaps even desirable - to
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take the profit, because there is little or no additional risk if the stock continues to
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drop. However, when the stock rises, it is not an equivalent situation. In that case, if
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the short seller sells his call for a profit and the stock subsequently rises even further,
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large losses could result.
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It may often be advisable to close the position if the call is at or near parity,
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in-the-money, by exercising the call. In most strategies, the option holder has no
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advantage in exercising the call because of the large dollar difference between
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stock commissions and option commissions. However, in the protected short sale
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strategy, the short seller is eventually going to have to cover the short stock in any
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case and incur the stock commission by so doing. It may be to his advantage to
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exercise the call and buy his stock at the striking price, thereby buying stock at a
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lower price and perhaps paying a slightly lower commission amount.
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Example: XYZ rises to 50 from the original short sale price of 40, and the XYZ July
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40 call is selling at 10 somewhere close to expiration. The position could be liquidat
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ed by either (1) buying the stock back at 50 and selling the call at 10, or (2) exercis
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ing the call to buy stock at 40. In the first case, one would pay a stock commission at
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a price of $50 per share plus an option commission on a $10 option. In the second
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case, the only commission would be a stock commission at the price of $40 per share.
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Since both actions accomplish the same end result - closing the position entirely for
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40 points plus commissions - clearly the second choice is less costly and therefore
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more desirable. Of course, if the call has time value premium in it of an amount
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greater than the commission savings, the first alternative should be used. |