37 lines
2.6 KiB
Plaintext
37 lines
2.6 KiB
Plaintext
154 Part II: Call Option Strategies
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A more bullish write is constructed by buying 200 shares of the underlying stock
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and writing three calls. To quickly verify that this ratio (3:2) is more bullish, again use
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49 for the stock price and 6 for the call price, and now assume that two round lots
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were purchased.
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Maximum profit= (50-49) x 2 + 3 x 6 = 20
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Downside break-even = 50 - 20/2 = 40
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Upside break-even= 50 + 20/(3 - 2) = 70
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Thus, this ratio of 3 calls against 200 shares of stock has break-even points of 40 and
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70, reflecting a more bullish posture on the underlying stock.
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A 2: 1 ratio may not necessarily be neutral. There is, in fact, a mathematically
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correct way of determining exactly what a neutral ratio should be. The neutral ratio
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is determined by dividing the delta of the written call into 1. Assume that the delta of
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the XYZ October 50 call in the previous example is .60. Then the neutral ratio is
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1.0/.60, or 5 to 3. This means that one might buy 300 shares and sell 5 calls. Using
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the formulae above, the details of this position can be observed:
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Maximum profit= (50 -49) x 3 + 5 x 6 = 33
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Downside break-even = 50 - 33/3 = 39
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Upside break-even = 50 + 33/(5 --3) = 66½
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According to the mathematics of the situation, then, this would be a neutral position
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initially. It is often the case that a 5:3 ratio is approximately neutral for an at-the
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money call.
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By now, the reader should have recognized a similarity between the ratio writ
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ing strategy and the reverse hedge (or simulated straddle) strategy presented in
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Chapter 4. The two strategies are the reverse of each other; in fact, this is how the
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reverse hedge strategy acquired its name. The ratio write has a profit graph that looks
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like a roof, while the reverse hedge has a profit graph that looks like a trough - the
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roof upside down. In one strategy the investor buys stock and sells calls, while the
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other strategy is just the opposite - the investor shorts stock and buys calls. Which
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one is better? The answer depends on whether the calls are "cheap" or "expensive."
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Even though ratio writing has limited profits and potentially large losses, the strate
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gy will result in a profit in a large majority of cases, if held to expiration. However,
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one may be forced to make adjustments to stock moves that occur prior to expiration.
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The reverse hedge strategy, with its limited losses and potentially large profits, pro
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vides profits only on large stock moves - a less frequent event. Thus, in stable mar
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kets, the ratio writing strategy is generally superior. However, in times of depressed
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option premiums, the reverse hedge strategy gains a distinct advantage. If calls are |