38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
C.,,er 5: Naked Call Writing 139
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third, or 33%, for the writer to lose money. Although there are not usually many
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optionable stocks selling at or just above $10 per share, these same out-of-the-money
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writers would also be attracted to selling a call with a striking price 15 when the stock
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is at 10, because a 50% upward move by the stock would be required for a loss to be
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realized.
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This strategy of selling deeply out-of-the-money calls has its apparent attraction
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in that the writer is assured of a profit unless the underlying stock can rally rather
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substantially before the call expires. The danger in this strategy is that one or two
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losses, perhaps amounting to only a couple of points each, could wipe out many peri
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ods of profits. The stock market does occasionally rally heavily in a short period, as
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witnessed repeatedly throughout history. Thus, the writer who is adopting this strat
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egy cannot regard it as a sure thing and certainly cannot afford to establish the writes
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and forget them. Close monitoring is required in case the market begins to rally, and
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by no means should losses be allowed to accumulate.
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The opposite end of the spectrum in naked call writing is the writing of fairly
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deeply in-the-money calls. Since an in-the-money call would not have much time
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value premium in it, this writer does not have much leeway to the upside. If the
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stock rallies at all, the writer of the deeply in-the-money naked call will normally
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experience a loss. However, should the stock drop in price, this writer will make
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larger dollar profits than will the writer of the out-of-the-money call. The sale of the
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deeply in-the-money call simulates the profits that a short seller could make, at least
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until the stock drops close to the striking price, since the delta of a deeply in-the
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money call is close to 1.
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Example: XYZ is selling at 60 and the July 50 call is selling for 10½. IfXYZ rises, the
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naked writer will lose money, because there is only ½ of a point of time value pre
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mium in the call. If XYZ falls, the writer will make profits on a point-for-point basis
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until the stock falls much closer to 50. That is, if XYZ dropped from 60 to 57, the call
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price would fall by almost 3 points as well. Thus, for quick declines by the stock, the
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deeply in-the-money write can provide profits nearly equal to those that the short
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seller could accumulate. Notice that if XYZ falls all the way to 50, the profits on the
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written call will be large, but will be accumulating at a slower rate as the time value
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premium builds up with the stock near the striking price.
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If one is looking to trade a stock on the short side for just a few points of nwve
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ment, he might use a deeply in-the-nwney naked write instead of shorting the stock.
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His investment will be smaller - 20% of the stock price for the write as compared to
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50% of the stock price for the short sale - and his return will thus be larger. (The
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requirement for the in-the-money amount is offset by applying the call's premium.) |