34 lines
2.5 KiB
Plaintext
34 lines
2.5 KiB
Plaintext
Cbapter 2: Covered Call Writing 91
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Covered writing against warrants is not a frequent practice because of the small
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number of warrants on optionable stocks and the problems inherent in checking
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available returns. However, in certain circumstances, the writer may actually gain a
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decided advantage by writing against a deep in-the-money warrant. It is often not
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advisable to write against a warrant that is at- or out-of-the-money, since it can
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decline by a large percentage if the underlying stock drops in price, producing a high
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risk position. Also, the writer's investment may increase in this case if he rolls down
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to an option with a striking price lower than the warrant's exercise price.
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WRITING AGAINST LEAPS
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A form of covered call writing can be constructed by buying LEAPS call options and
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selling shorter-term out-of-the-money calls against them. This strategy is much like
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writing calls against warrants. This strategy is discussed in more detail in Chapter 25
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on LEAPS, under the subject of diagonal spreads.
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PERCS
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The PERCS (Preferred Equity Redemption Cumulative Stock) is a form of covered
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writing. It is discussed in Chapter 32.
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THE INCREMENTAL RETURN CONCEPT OF COVERED WRITING
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The incremental return concept of covered call writing is a way in which the covered
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writer can earn the full value of stock appreciation between todays stock price and a
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target sale price, which may be substantially higher. At the same time, the writer can
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earn an incremental, positive return from writing options.
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Many institutional investors are somewhat apprehensive about covered call
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writing because of the upside limit that is placed on profit potential. If a call is writ
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ten against a stock that subsequently declines in price, most institutional managers
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would not view this as an unfavorable situation, since they would be outperforming
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all managers who owned the stock and who did not write a call. However, if the stock
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rises substantially after the call is written, many institutional managers do not like
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having their profits limited by the written call. This strategy is not only for institu
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tional money managers, although one should have a relatively substantial holding in
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an underlying stock to attempt the strategy - at least 500 shares and preferably 1,000
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shares or more. The incremental return concept can be used by anyone who is plan
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ning to hold his stock, even if it should temporarily decline in price, until it reaches a
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predetermined, higher price at which he is willing to sell the stock. |