37 lines
2.7 KiB
Plaintext
37 lines
2.7 KiB
Plaintext
Cl,apter 2: Covered Call Writing 45
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To make a true comparison between the two covered writes, one must look at
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what happens with the stock between 40 and 50 at expiration. The in-the-money
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write attains its maximum profit anywhere within that range. Even a 5-point decline
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by the underlying stock at expiration would still leave the in-the-money writer with
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his maximum profit. However, realizing the maximum profit potential with an out-of
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the-money covered write always requires a rise in price by the underlying stock. This
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further illustrates the more conservative nature of the in-the-money write. It should
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be noted that in-the-money writes, although having a smaller profit potential, can still
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be attractive on a percentage return basis, especially if the write is done in a margin
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account.
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One can construct a more aggressive position by writing an out-of-the-money
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call. One's outlook for the underlying stock should be bullish in that case. If one is
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neutral or moderately bearish on the stock, an in-the-money covered write is more
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appropriate. If one is truly bearish on a stock he owns, he should sell the stock instead
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of establishing a covered write.
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THE TOTAL RETURN CONCEPT
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OF COVERED WRITING
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When one writes an out-of-the-money option, the overall position tends to reflect
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more of the result of the stock price movement and less of the benefits of writing the
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call. Since the premium on an out-of-the-money call is relatively small, the total posi
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tion will be quite susceptible to loss if the stock declines. If the stock rises, the posi
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tion will make money regardless of the result in the option at expiration. On the other
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hand, an in-the-money write is more of a "total" position - taking advantage of the
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benefit of the relatively large option premium. If the stock declines, the position can
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still make a profit; in fact, it can even make the maximum profit. Of course, an in
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the-money write will also make money if the stock rises in price, but the profit is not
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generally as great in percentage terms as is that of an out-of-the-money write.
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Those who believe in the total return concept of covered writing consider both
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downside protection and maximum potential return as important factors and are
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willing to have the stock called away, if necessary, to meet their objectives. When
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premiums are moderate or small, only in-the-money writes satisfy the total return
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philosophy.
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Some covered writers prefer never to lose their stock through exercise, and as
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a result will often write options quite far out-of-the-money to minimize the chances
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of being called by expiration. These writers receive little downside protection and, to
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make money, must depend almost entirely on the results of the stock itself. Such a |