37 lines
2.9 KiB
Plaintext
37 lines
2.9 KiB
Plaintext
40 Part II: Call Option Strategies
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THE BENEFITS OF AN INCREASE IN STOCK PRICE
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If XYZ increases in price moderately, the trader may be able to have the best of both
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worlds.
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Example: If XYZ is at or just below 50 at July expiration, the call still expires worth
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less, and the investor makes the $300 from the option in addition to having a small
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profit from his stock purchase. Again, he still owns the stock.
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Should XYZ increase in price by expiration to levels above 50, the covered
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writer has a choice of alternatives. As one alternative, he could do nothing, in which
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case the option would be assigned and his stock would be called away at the striking
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price of 50. In that case, his profits would be equal to the $300 received from selling
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the call plus the profit on the increase of his stock from the purchase price of 48 to
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the sale price of 50. In this case, however, he would no longer own the stock. If as
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another alternative he desires to retain his stock ownership, he can elect to buy back
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( or cover) the written call in the open market. This decision might involve taking a
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loss on the option part of the covered writing transaction, but he would have a cor
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respondingly larger profit, albeit unrealized, from his stock purchase. Using some
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specific numbers, one can see how this second alternative works out.
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Example: XYZ rises to a price of 60 by July expiration. The call option then sells near
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its intrinsic value of 10. If the investor covers the call at 10, he loses $700 on the
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option portion of his covered write. (Recall that he originally received $300 from the
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sale of the option, and now he is buying it back for $1,000.) However, he relieves the
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obligation to sell his stock at 50 ( the striking price) by buying back the call, so he has
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an unrealized gain of 12 points in the stock, which was purchased at 48. His total
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profit, including both realized and unrealized gains, is $500.
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This profit is exactly the same as he would have made if he had let his stock be
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called from him. If called, he would keep the $300 from the sale of the call, and he
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would make 2 points ( $200) from buying the stock at 48 and selling it, via exercise, at
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50. This profit, again, is a total of $500. The major difference between the two cases
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is that the investor no longer owns his stock after letting it be called away, whereas
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he retains stock ownership if he buys back the written call. Which of the two alter
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natives is the better one in a given situation is not always clear.
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No matter how high the stock climbs in price, the profit from a covered write is
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limited because the writer has obligated himself to sell stock at the striking price. The
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covered writer still profits when the stock climbs, but possibly not by as much as he
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might have had he not written the call. On the other hand, he is receiving $300 of
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immediate cash inflow, because the writer may take the premium immediately and |