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60 Part II: Call Option Strategies
is somewhat misleading, however, since the more volatile stocks will always offer a
large percentage of downside protection (their premiums are higher). The difficulty
arises in trying to decide if 10% protection on a volatile stock is better than or worse
than, say, 6% protection on a less volatile stock. There are mathematical ways to
quantify this, but because of the relatively advanced nature of the computations
involved, they are not discussed until later in the text, in Chapter 28 on mathemati­
cal applications.
Rather than go into involved mathematical calculations, many covered writers
use the percentage of downside protection and will only consider writes that offer a
certain minimum level of protection, say 10%. Although this is not exact, it does
strive to ensure that one has minimal downside protection in a covered write, as well
as an acceptable return. A standard figure that is often used is the 10% level of pro­
tection. Alternatively, one may also require that the write be a certain percent in-the­
money, say 5%. This is just another way of arriving at the same concept.
THE IMPORTANCE OF STRATEGY
In a conservative option writing strategy, one should be looking for minimum returns
if unchanged of 1 % per month, with downside protection of at least 10%, as general
guidelines. Employing such criteria automatically forces one to write in-the-money
options in line with the total return concept. The overall position constructed by
using such guidelines as these will be a relatively conservative position - regardless
of the volatility of the underlying stock - since the levels of protection will be large
but a reasonable return can still be attained. There is a danger, however, in using
fixed guidelines, because market conditions change. In the early days of listed
options, premiums were so large that virtually every at- or in-the-money covered
write satisfied the foregoing criteria. However, now one should work with a ranked
list of covered writing positions, or perhaps two lists. A daily computer ranking of
either or both of the following categories would help establish the most attractive
types of conservative covered writes. One list would rank, by annualized return, the
writes that afford, as a minimum, the desired downside protection level, say 10%.
The other list would rank, by percentage downside protection, all the writes that
meet at least the minimum acceptable return if unchanged, say 12%. If premium lev­
els shrink and the lists become quite small on a daily basis, one might consider
expanding the criteria to view more potential situations. On the other hand, if pre­
miums expand dramatically, one might consider using more restrictive criteria, to
reduce the number of potential writing candidates.
A different group of covered writers may favor a more aggressive strategy of out­
of-the-money writes. There is some mathematical basis to believe, in the long rnn, that