34 lines
2.4 KiB
Plaintext
34 lines
2.4 KiB
Plaintext
174 Part II: Call Option Strategies
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would merely buy the October 30 call outright. However, the sale of the October 35
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call against the purchase of the October 30 allows him to take a position that will out
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perform the outright purchase of the October 30, dollarwise, as long as the stock does
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not rise above 36 by expiration. This fact is demonstrated by the dashed line in Figure
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7-1.
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Therefore, the strategist establishing the bull spread is bullish, but not overly so.
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To verify that this comparison is correct, note that if one bought the October 30 call
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outright for 3 points, he would have a 3-point profit at expiration if XYZ were at 36.
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Both strategies have a 3-point profit at 36 at expiration. Below 36, the bull spread
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does better because the sale of the October 35 call brings in the extra point of pre
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mium. Above 36 at expiration, the outright purchase outperforms the bull spread,
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because there is no limit on the profits that can occur in an outright purchase situa
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tion.
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The net investment required for a bull spread is the net debit plus commissions.
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Since. the spread must be transacted in a margin account, there will generally be a
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minimum equity requirement imposed by the brokerage firm. In addition, there may
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be a maintenance requirement by some brokers. Suppose that one was establishing
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10 spreads at the prices given in the example above. His investment, before com
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missions, would be $2,000 ($200 per spread), plus commissions. It is a simple matter
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to compute the break-even point and the maximum profit potential of a call bull
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spread:
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Break-even point= Lower striking price+ Net debit of spread
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Maximum profit _ Higher striking _ Lower striking _ Net debit
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potential - price price of spread
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In the example above, the net debit was 2 points. Therefore, the break-even
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point would be 30 + 2, or 32. The maximum profit potential would be 35 - 30 - 2, or
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3 points. These figures agree with Table 7-1 and Figure 7-1. Commissions may rep
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resent a significant percentage of the profit and net investment, and should therefore
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be calculated before establishing the position. If these commissions are included in
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the net debit to establish the spread, they conveniently fit into the preceding formu
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lae. Commission charges can be reduced percentagewise by spreading a larger quan
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tity of calls. For this reason, it is generally advisable to spread at least 5 options at a
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time. |