36 lines
2.6 KiB
Plaintext
36 lines
2.6 KiB
Plaintext
126 Part II: Call Option Strategies
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Generally, the underlying stock selected for the reverse hedge should be
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volatile. Even though option premiums are larger on these stocks, they can still be
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outdistanced by a straight-line move in a volatile situation. Another advantage of uti
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lizing volatile stocks is that they generally pay little or no dividends. This is desirable
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for the reverse hedge, because the short seller will not be required to pay out as
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much.
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The technical pattern of the underlying stock can also be useful when selecting
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the position. One generally would like to have little or no technical support and
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resistance within the loss area. This pattern would facilitate the stock's ability to make
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a fairly quick move either up or down. It is sometimes possible to find a stock that is
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in a wide trading range, frequently swinging from one side of the range to the other.
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If a reverse hedge can be set up that has its loss area well within this trading range,
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the position may also be attractive.
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Example: The XYZ stock in the previous example is trading in the range 30 to 50,
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perhaps swinging to one end and then the other rather frequently. Now the reverse
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hedge example position, which would make profits above 46 or below 34, would
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appear more attractive.
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FOLLOW-UP ACTION
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Since the reverse hedge has a built-in limited loss feature, it is not necessary to take
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any follow-up action to avoid losses. The investor could quite easily put the position
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on and take no action at all until expiration. This is often the best method of follow
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up action in this strategy.
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Another follow-up strategy can be applied, although it has some disadvantages
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associated with it. This follow-up strategy is sometimes known as trading against the
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straddle. When the stock moves far enough in either direction, the profit on that side
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can be taken. Then, if the stock swings back in the opposite direction, a profit can
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also be made on the other side. Two examples \vill show how this type of follow-up
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strategy works.
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Example 1: The XYZ stock in the previous example quickly moves down to 32. At
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that time, an 8-point profit could be taken on the short sale. This would leave two
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long calls. Even if they expired worthless, a 6-point loss is all that would be incurred
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on the calls. Thus, the entire strategy would still have produced a profit of 2 points.
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However, if the stock should rally above 40, profits could be made on the calls as well.
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A slight variation would be to sell one of the calls at the same time the stock profit is
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taken. This would result in a slightly larger realized profit; but if the stock rallied back |