39 lines
2.9 KiB
Plaintext
39 lines
2.9 KiB
Plaintext
152 Part II: Call Option Strategies
|
||
Example: The writer is buying 100 XYZ at 49 and selling 2 October 50 calls at 6
|
||
points apiece. It was seen, by inspection, that the break-even points in the position
|
||
are 37 on the downside and 63 on the upside. A mathematical formula allows one to
|
||
quickly compute the break-even points for a 2:1 ratio write.
|
||
Points of maximum profit = Strike price - Stock price + 2 x Call price
|
||
Downside break-even point = Strike price - Points of maximum profit
|
||
= Stock price - 2 x Call price
|
||
Upside break-even point = Strike price + Points of maximum profit
|
||
In this example, the points of maximum profit are 50 - 49 + 2 x 6, or 13. Thus,
|
||
the downside break-even point would be 37 (50 - 13) and the upside break-even
|
||
point would be 63 (50 + 13). These numbers agree with the figures determined ear
|
||
lier by analyzing the position.
|
||
This profit range is quite clearly wide enough to allow for defensive action
|
||
should the underlying stock rise to the next highest strikes of 55 or 60, or fall to the
|
||
next two lower strikes, at 45 and 40. In practice, a ratio write is not automatically a
|
||
good position merely because the profit range extends far enough. Theoretically,
|
||
one would want the profit range to be wide in relation to the volatility of the under
|
||
lying stock. If the range is wide in relation to the volatility and the break-even
|
||
points encompass the next higher and lower striking prices, a desirable position is
|
||
available. Volatile stocks are the best candidates for ratio writing, since their pre
|
||
miums will more easily satisfy both these conditions. A nonvolatile stock may, at
|
||
times, have relatively large premiums in its calls, but the resulting profit range may
|
||
still not be wide enough numerically to ensure that follow-up action could be taken.
|
||
Specific measures for determining volatility may be obtained from many data serv
|
||
ices and brokerage firms. Moreover, methods of computing volatility are present
|
||
ed later in the chapter on mathematical applications, and probabilities are further
|
||
addressed in the chapters on volatility trading.
|
||
Technical support and resistance levels are also important in establishing the
|
||
position. If both support and resistance lie within the profit range, there is a better
|
||
chance that the stock will remain within the range. A position should not necessarily
|
||
be rejected if there is not support and resistance within the profit range, but the
|
||
writer is then subjecting himself to a possible undeterred move by the stock in one
|
||
direction or the other.
|
||
The ratio writer is generally a neutral strategist. He tries to take in the most
|
||
time premium that he can to earn the premium erosion while the stock remains rel
|
||
atively unchanged. If one is more bullish on a particular stock, he can set up a 2:1
|
||
ratio write with out-of~the-money calls. This allows more room to the upside than to
|
||
the downside, and therefore makes the position slightly more bullish. Conversely, if |