37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
74 Part II: Call Option Strategies
|
||
with enough premium to realize any profit if the stock were then called away at expi
|
||
ration. These situations arise more commonly on lower-priced stocks, where the
|
||
striking prices are relatively far apart in percentage terms. Out-of-the-money writes
|
||
are more susceptible to this problem than are in-the-money writes. Although it is not
|
||
emotionally satisfying to be in an investment position that cannot produce a profit -
|
||
at least for a limited period of time - it may still be beneficial to roll down to protect
|
||
as much of the stock price decline as possible.
|
||
Example: For the covered write described as "buy XYZ at 20, sell the January 20 call
|
||
at 2," the stock unexpectedly drops very quickly to 16, and the following prices exist:
|
||
XYZ common, 16;
|
||
XYZ January 20 call,½; and
|
||
XYZ January 15 call, 2½.
|
||
The covered writer is faced with a difficult choice. He currently has an unrealized
|
||
loss of 2½ points - a 4-point losson the stock which is partially offset by a 1 ½-point
|
||
gain on the January 20 call. This represents a fairly substantial percentage loss on his
|
||
investment in a short period of time. He could do nothing, hoping for the stock to
|
||
recover its loss. Unfortunately, this may prove to be wishful thinking.
|
||
If he considers rolling down, he will not be excited by what he sees. Suppose
|
||
that the writer wants to roll down from the January 20 to the January 15. He would
|
||
thus buy the January 20 at ½ and sell the January 15 at 2½, for a net credit of 2
|
||
points. By rolling down, he is obligating himself to sell his stock at 15, the striking
|
||
price of the January 15 call. Suppose XYZ were above 15 in January and were called
|
||
away. How would the writer do? He would lose 5 points on his stock, since he origi
|
||
nally bought it at 20 and is selling it at 15. This 5-point loss is substantially offset by
|
||
his option profits, which amount to 4 points: 1 ½ points of profit on the January 20,
|
||
sold at 2 and bought back at ½, plus the 2½ points received from the sale of the
|
||
January 15. However, his net result is a 1-point loss, since he lost 5 points on the stock
|
||
and made only 4 points on the options. Moreover, this 1-point loss is the best that he
|
||
can hope for! This is true because, as has been demonstrated several times, a covered
|
||
writing position makes its maximum profit anywhere above the striking price. Thus,
|
||
by rolling down to the 15 strike, he has limited the position severely, to the extent of
|
||
"locking in a loss."
|
||
Even considering what has been shown about this loss, it is still correct for this
|
||
writer to roll down to the January 15. Once the stock has fallen to 16, there is noth
|
||
ing anybody can do about the unrealized losses. However, if the writer rolls down, he
|
||
can prevent the losses from accumulating at a faster rate. In fact, he will do better by |