40 lines
3.1 KiB
Plaintext
40 lines
3.1 KiB
Plaintext
Chapter 2: Covered Call Writing
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A WORD OF CAUTION
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65
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The stockholder who owns stock from a previous purchase and later contemplates
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writing calls against that stock must be aware of his situation. He must realize and
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accept the fact that he might lose his stock via assignment. If he is determined to
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retain ownership of the stock, he may have to buy back the written option at a loss
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should the underlying stock increase in price. In essence, he is limiting the stock's
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upside potential. If a stockholder is going to be frustrated and disappointed when he
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is not fully participating during a rally in his stock, he should not write a call in the
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first place. Perhaps he could utilize the incremental return concept of covered writ
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ing, a topic covered later in this chapter.
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As stressed earlier, a covered writing strategy involves viewing the stock and
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option as a total position. It is not a strategy wherein the investor is a stockholder who
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also trades options against his stock position. If the stockholder is selling the calls
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because he thinks the stock is going to decline in price and the call trade itself will be
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profitable, he may be putting himself in a tenuous position. Thinking this way, he will
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probably be satisfied only if he makes a profit on the call trade, regardless of the
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unrealized result in the underlying stock. This sort of philosophy is contrary to a cov
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ered writing strategy philosophy. Such an investor - he is really becoming a trader
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should carefully review his motives for writing the call and anticipate his reaction if
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the stock rises substantially in price after the call has been written.
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In essence, writing calls against stock that you have no intention of selling is
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tantamount to writing naked calls! If one is going to be extremely frustrated, perhaps
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even experiencing sleepless nights, if his stock rises above the strike price of the call
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that he has written, then he is experiencing trials and tribulations much as the writer
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of a naked call would if the same stock move occurred. This is an unacceptable level
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of emotional worry for a true covered writing strategist.
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Think about it. If you have some very low-cost-basis stock that you don't really
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want to sell, and then you sell covered calls against that stock, what do you wish will
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happen? Most certainly you wish that the options will expire worthless (i.e., that the
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stock won't get called away) - exactly what a naked writer wishes for.
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The problems can be compounded if the stock rises, and one then decides to
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roll these calls. Rather than spend a small debit to close out a losing position, an
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investor may attempt to roll to more distant expiration months and higher strike
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prices in order to keep bringing in credits. Eventually, he runs out of room as the
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lower strikes disappear, and he has to either sell some stock or pay a big debit to buy
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back the written calls. So, if the underlying stock continues to run higher, the writer
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suffers emotional devastation as he attempts to "fight the market." There have been
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some classic cases of Murphy's law whereby people have covered the calls at a big |