33 lines
1.9 KiB
Plaintext
33 lines
1.9 KiB
Plaintext
226 Part II: Call Option Strategies
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more heavily on the near-term April calls than on the longer-term July call. Once the
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strategist has this information, he might then look at a chart of the underlying stock.
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If there is resistance for XYZ below 53, his eventual break-even point at April expi
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ration, he could then feel more confident about this spread.
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FOLLOW-UP ACTION
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The main purpose of defensive action in this strategy is to limit losses if the stock
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should rally before April e:xJ)iration. The strategist should be quick to close out the
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spread before any serious losses accrue. The long call quite adequately compen
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sates for the losses on the short calls up to a certain point, a fact demonstrated in
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Table 12-1. However, the stock cannot be allowed to run. A rule of thumb that is
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often useful is to close the spread if the stock breaks out above technical resistance
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or if it breaks above the eventual break-even point at expiration. In the example
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above, the strategist would close the spread if, at any time, XYZ rose above 53
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(before April expiration, of course).
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If a significant amount of time has passed, the strategist might act even more
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quickly in closing the spread. As was shown earlier, if the stock rallies to 50 with only
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a few weeks of time remaining, the spread may actually be at a slight profit at that
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time. It is often the best course of action to take the small profit, if the stock rises
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above the striking price.
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TABLE 12-1.
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Break-even points changing over time.
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Estimated Estimated
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Days Remaining until Break-Even Point April 50 July 50
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April Expiration (Stock Price) Price Price
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90 45 11/2
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60 48 Jl/2 21/2
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30 51 21/2 4 1/2
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0 53 3 51/2
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THE PROBABILITIES ARE GOOD
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This is a strategy with a rather large probability of profit, provided that the defensive
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action described above is adhered to. The spread will make money if the stock never
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rallies above the striking price, since the spread is established for a credit. This in |