34 lines
2.3 KiB
Plaintext
34 lines
2.3 KiB
Plaintext
112 Part II: Call Option Strategies
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DEFENSIVE ACTION
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Two follow-up strategies are sometimes employed by the call buyer when the under
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lying stock declines in price. Both involve spread strategies; that is, being long and
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short two different calls on the same underlying stock simultaneously. Spreads are
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discussed in detail in later chapters. This discussion of spreads applies only to their
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use by the call buyer.
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·"Rolling Down." If an option holder owns an option at a currently unreal
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ized loss, it may be possible to greatly increase the chances of making a limited
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profit on a relatively small rebound in the stock price. In certain cases, the
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investor may be able to implement such a strategy at little or no increase in risk.
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Many call buyers have encountered a situation such as this: An XYZ October 35
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call was originally bought for 3 points in hopes of a quick rise in the stock price.
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However, because of downward movements in the stock- to 32, say- the call is now
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at 1 ½ with October expiration nearer. If the call buyer still expects a mild rally in the
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stock before expiration, he might either hold the call or possibly "average down" (buy
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more calls at I½). In either case he will need a rally to nearly 38 by expiration in
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order to break even. Since this would necessitate at least a 15% upward move by the
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stock before expiration, it cannot be considered very likely. Instead, the buyer should
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consider implementing the following strategy, which will be explained through the
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use of an example.
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Example: The investor is long the October 35 call at this time:
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XYZ, 32;
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XYZ October 35 call, 1 ½; and
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XYZ October 30 call, 3.
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One could sell two October 35's and, at the same time, buy one October 30 for no
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additional investment before commissions. That is, the sale of 2 October 35's at $150
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each would bring in $300, exactly the cost, before commissions, of buying the
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October 30 call. This is the key to implementing the roll-down strategy: that one be
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able to buy the lower strike call and sell two of the higher strike calls for nearly even
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money.
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Note that the investor is now short the call that he previously owned, the
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October 35. Where he previously owned one October 35, he has now sold two of
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them. He is also now long one October 30 call. Thus, his position is: |