44 lines
2.3 KiB
Plaintext
44 lines
2.3 KiB
Plaintext
0.,,., 3: Call Buying
|
||
long 1 XYZ October 30 call,
|
||
1hort 1 XYZ October 35 call.
|
||
113
|
||
This is technically known as a bull spread, but the terminology is not important.
|
||
Table 3-4 summarizes the transactions that the buyer has made to acquire this
|
||
spread. The trader now "owns" the spread at a cost of $300, plus commissions. By
|
||
making this trade, he has lowered his break-even point significantly without increas
|
||
ing his risk. However, the maximum profit potential has also been limited; he can no
|
||
longer capitalize on a strong rebound by the underlying stock.
|
||
In order to see that the break-even point has been lowered, consider what the
|
||
results are~ is at 33 at October expiration. The October 30 call would be worth
|
||
3 points and the October 35 would expire worthless with XYZ at 33. Thus, the
|
||
October 30 call could be sold to bring in $300 at that time, and there would not be
|
||
any expense to buy back the October 35. Consequently, the spread could be liqui
|
||
dated for $300, exactly the amount for which it was "bought." The spread then breaks
|
||
even at 33 at expiration. If the call buyer had not rolled down, his break-even point
|
||
would be 38 at expiration, for he paid 3 points for the original October 35 call and he
|
||
would thus need XYZ to be at 38 in order to be able to liquidate the call for 3 points.
|
||
Clearly, the stock has a better chance of recovering to 33 than to 38. Thus, the call
|
||
buyer significantly lowers his break-even point by utilizing this strategy.
|
||
Lowering the break-even point is not the investor's only concern. He must also
|
||
be aware of what has happened to his profit and loss opportunities. The risk remains
|
||
essentially the same the $300 in debits, plus commissions, that has been paid out.
|
||
The risk has actually increased slightly, by the amount of the commissions spent in
|
||
"rolling down." However, the stock price at which this maximum loss would be real
|
||
ized has been lowered. With the original long call, the October 35, the buyer would
|
||
lose the entire $300 investment anywhere below 35 at October expiration. The
|
||
TABLE 3-4.
|
||
Transactions in bull spread.
|
||
Original trade
|
||
Later trade
|
||
Net position
|
||
Trade
|
||
Buy 1 October 35 call at 3
|
||
Sell 2 October 35 calls at 1 1/2
|
||
Buy 1 October 30 call at 3
|
||
Long 1 October 30 call
|
||
Short 1 October 35 call
|
||
Cost before Commissions
|
||
$300 debit
|
||
$300 credit
|
||
$300 debit
|
||
$300 debit |