38 lines
3.1 KiB
Plaintext
38 lines
3.1 KiB
Plaintext
82 Part II: Call Option Strategies
|
||
has amassed a fairly large series of debits from previous rolls; or (2) he begins to sell
|
||
some out-of-the-money naked puts to bring in credits to reduce the cost of continu
|
||
ally rolling the calls up for debits. This latter action is even worse, because the entire
|
||
position is now leveraged tremendously, and a sharp drop in the stock price may
|
||
cause horrendous losses - perhaps enough to wipe out the entire account. As fate
|
||
would have it, these mistakes are usually made when the stock is near a top in price.
|
||
Any price decline after such a dramatic rise is usually a sharp and painful one.
|
||
The best way to avoid this type of potentially serious mistake is to allow the
|
||
stock to be called away at some point. Then, using the funds that are released, either
|
||
establish a new position in another stock or perhaps even utilize another strategy for
|
||
a while. If that is not feasible, at least avoid making a radical change in strategy after
|
||
the stock has had a particularly strong rise. Leveraging the position through naked
|
||
put sales on top of rolling the calls up for debits should expressly be avoided.
|
||
The discussion to this point has been directed at rolling up before expiration. At
|
||
or near expiration, when the time value premium has disappeared from the written
|
||
call, one may have no choice but to write the next-higher striking price if he wants to
|
||
retain his stock. This is discussed when we analyze action to take at or near expiration.
|
||
If the underlying stock rises, one's choices are not necessarily limited to rolling
|
||
up or doing nothing. As the stock increases in price, the written call will lose its time
|
||
premium and may begin to trade near parity. The writer may decide to close the posi
|
||
tion himself - perhaps well in advance of expiration - by buying back the written call
|
||
and selling the stock out, hopefully near parity.
|
||
Example: A customer originally bought XYZ at 25 and sold the 6-month July 25 for
|
||
3 points - a net of 22. Now, three months later, XYZ has risen to 33 and the call is
|
||
trading at 8 (parity) because it is so deeply in-the-money. At this point, the writer may
|
||
want to sell the stock at 33 and buy back the call at 8, thereby realizing an effective
|
||
net of 25 for the covered write, which is his maximum profit potential. This is cer
|
||
tainly preferable to remaining in the position for three more months with no more
|
||
profit potential available. The advantage of closing a parity covered write early is that
|
||
one is realizing the maximum return in a shorter period than anticipated. He is there
|
||
by increasing his annualized return on the position. Although it is generally to the
|
||
cash writer's advantage (margin writers read on) to take such action, there are a few
|
||
additional costs involved that he would not experience if he held the position until
|
||
the call expired. First, the commission for the option purchase (buy-back) is an addi
|
||
tional expense. Second, he will be selling his stock at a higher price than the striking
|
||
price, so he may pay a slightly higher commission on that trade as well. If there is a
|
||
dividend left until expiration, he will not be receiving that dividend if he closes the |