37 lines
2.9 KiB
Plaintext
37 lines
2.9 KiB
Plaintext
46 Part II: Call Option Strategies
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philosophy is more like being a stockholder and trading options against one's stock
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position than actually operating a covered writing strategy. In fact, some covered
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writers will attempt to buy back written options for quick profits if such profits mate
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rialize during the life of the covered write. This, too, is a stock ownership philosophy,
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not a covered writing strategy. The total return concept represents the true strategy
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in covered writing, whereby one views the entire position as a single entity and is not
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predominantly concerned with the results of his stock ownership.
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THE CONSERVATIVE COVERED WRITE
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Covered writing is generally accepted to be a conservative strategy. This is because
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the covered writer always has less risk than a stockholder, provided that he holds the
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covered write until expiration of the written call. If the underlying stock declines, the
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covered writer will always offset part of his loss by the amount of the option premi
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um received, no matter how small.
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As was demonstrated in previous sections, however, some covered writes are
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clearly more conservative than others. Not all option writers agree on what is meant
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by a conservative covered write. Some believe that it involves writing an option
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(probably out-of-the-money) on a conservative stock, generally one with high yield
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and low volatility. It is true that the stock itself in such a position is conservative, but
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the position is more aptly termed a covered write on a conservative stock. This is dis
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tinctly different from a conservative covered write.
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A true conservative covered write is one in which the total position is conserva
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tive - offering reduced risk and a good probability of making a profit. An in-the-money
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wiite, even on a stock that itself is not conservative, can become a conservative total
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position when the option itself is properly chosen. Clearly, an investor cannot write
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calls that are too deeply in-the-money. If he did, he would get large amounts of down
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side protection, but his returns would be severely limited. If all that one desired was
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maximum protection of his money at a nominal rate of profit, he could leave the
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money in a bank. Instead, the conservative covered writer strives to make a potential
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ly acceptable return while still receiving an above-average amount of protection.
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Example: Again assume XYZ common stock is selling at 45 and an XYZ July 40 call
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is selling at 8. A covered write of the XYZ July 40 would require, in a cash account,
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an investment of $3,700 - $4,500 to purchase 100 shares of XYZ, less the $800
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received in option premiums. The write has a maximum profit potential of $300. The
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potential return from this position is therefore $300/$3, 700, just over 8% for the peri
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od during which the write must be held. Since it is most likely that the option has 9
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months of life or less, this return would be well in excess of 10% on a per annum |