40 lines
3.3 KiB
Plaintext
40 lines
3.3 KiB
Plaintext
276 Part Ill: Put Option Strategies
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The purchase of an out-of the-money put option can eliminate the risk of large
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potential losses for the covered write, although the money spent for the put purchase
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will reduce the overall return from the covered write. One must therefore include
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the put cost in his initial calculations to determine if it is worthwhile to buy the put.
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Example: X'YZ is at 39 and there is an XYZ October 40 call selling for 3 points and an
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XYZ October 35 put selling for ½ point. A covered write could be established by buy
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ing the common at 39 and selling the October 40 call for 3. This covered write would
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have a maximum profit potential of 4 points if XYZ were anywhere above 40 at expi
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ration. The write would lose money if XYZ were anywhere below 36, the break-even
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point, at October expiration. By also purchasing the October 35 put at the time the
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covered write is initiated, the covered writer will limit his profit potential slightly, but
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will also greatly reduce his risk potential. If the put purchase is added to the covered
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write, the maximum profit potential is reduced to 3½ points at October expiration. The
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break-even point moves up to 36½, and the writer will experience some loss if XYZ is
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below 36½ at expiration. However, the most that the writer could lose would be 1 ¼
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points if XYZ were below 35 at expiration. The purchase of the put option produces
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this loss-limiting effect. Table 17-2 and Figure 17-2 depict the profitability of both the
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regular covered write and the covered write that is protected by the put purchase.
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Commissions should be carefully included in the covered writer's return calcula
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tions, as well as the cost of the put. It was demonstrated in Chapter 2 that the covered
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writer must include all commissions and margin interest expenses as well as all divi
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dends received in order to produce an accurate "total return" picture of the covered
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write. Figure 17-2 shows that the break-even point is raised slightly and the overall prof
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it potential is reduced by the purchase of the put. However, the maximum risk is quite
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small and the writer need never be forced to roll down in a disadvantageous situation.
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Recall that the covered writer who does not have the protective put in place is
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forced to roll down in order to gain increased downside protection. Rolling down
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merely means that he buys back the call that is currently written and writes another
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call, with a lower striking price, in its place. This rolling-down action can be helpful
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if the stock stabilizes after falling; but if the stock reverses and climbs upward in price
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again, the covered writer who rolled down would have limited his gains. In fact, he
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may even have "locked in" a loss. The writer who has the protective put need not be
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bothered with such things. He never has to roll down, for he has a limited maximum
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loss. Therefore, he should never get into a "locked-in" loss situation. This can be a
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great advantage, especially from an emotional viewpoint, because the writer is never
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forced to make a decision as to the future price of the stock in the middle of the
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stock's decline. With the put in place, he can feel free to take no action at all, since
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his overall loss is limited. If the stock should rally upward later, he will still be in a
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position to make his maximum profit. |