31 lines
1.9 KiB
Plaintext
31 lines
1.9 KiB
Plaintext
Mixing Exposure • 245
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stock, so it makes sense to count the dividend inflow as one element that
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reduces your EBP . In formula form, this turns out to be
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−−Coveredc allr eturn= premiumr eceivedf romc all+ projectedd ividends
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stockp rice premiumf romc allp rojected dividends
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For a short put, you have no right to receive the dividend, so I find the
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return using the following formula:
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−Shortp ut return= premiumr eceivedf roms hort put
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strikepricep remium from shortp ut
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Common Pitfalls
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Taking Profit
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One mistake I hear people make all the time is saying that they are going
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to “take profit” using a covered call. Writing a covered call is taking profit
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in the sense that you no longer enjoy capital gains from the stock’s appre-
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ciation, but it is certainly not taking profit in the sense of being immune
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to falls in the market price of the stock. The call premium you receive will
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cushion a stock price drop, but it will certainly not shield you from it. If
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you want to take profits on a successful stock trade, hit the “Sell” button.
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Locking in a Loss
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A person sent me an e-mail telling me that she had bought a stock at $17,
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sold covered calls on it when it got to $20 (in order to “take profits”), and
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now that the stock was trading for $11, she wanted to know how she could
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“repair” her position using options. Unfortunately, options are not magical
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tools and cannot make up for a prior decision to buy a stock at $17 and ride
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it down to $11.
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If you are in such a position, don’t panic. It will be tempting to write
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a new call at the lower ATM price ($11 in this example) because the cash
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inflow from that covered call will be the most. Don’t do it. By writing a
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covered call at the lower price, you are—if the shares are called away—
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locking in a realized loss on the position. Y ou can see this clearly if you list
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each transaction in the example separately. |