40 lines
2.6 KiB
Plaintext
40 lines
2.6 KiB
Plaintext
Gapter 3: Call Buying
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TABLE 3-1.
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Present situation on XYZ October calls.
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Original Trade
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XYZ common: 48
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Bought XYZ October 50 at 3
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109
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Current Prices
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XYZ Common: 58
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XYZ October 50: 9
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XYZ October 60: 3
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Each of these actions would produce different levels of risk and reward from
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this point forward. If the holder sells the October 50 call, he makes a 6-point profit,
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less commissions, and terminates the position. He can realize no further appreciation
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from the call, nor can he lose any of his current profits; he has realized a 6-point gain.
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This is the least aggressive tactic of the four: If the underlying stock continues to
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advance and rises above 63, any of the other three strategies will outperform the
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complete liquidation of the call. However, if the underlying stock should instead
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decline below 50 by expiration, this action would have provided the most profit of the
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four strategies.
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The other simple tactic, the fourth one listed, is to do nothing. If the call is then
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held to expiration, this tactic would be the riskiest of the four: It is the only one that
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could produce a loss at expiration if XYZ fell back below 50. However, if the under
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lying stock continues to rise in price, more profits would accrue on the call. Every call
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buyer realizes the ramifications of these two tactics - liquidating or doing nothing
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and is generally looking for an alternative that might allow him to reduce some of his
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risk without cutting off his profit potential completely. The remaining two tactics are
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geared to this purpose: limiting the total risk while providing the opportunity for fur
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ther profits of an amount greater than those that could be realized by liquidating.
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The strategy in which the holder sells the call that he is currently holding, the
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October 50, and uses part of the proceeds to buy the call at the next higher strike is
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called rolling up. In this example, he could sell the October 50 at 9, pocket his initial
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3-point investment, and use the remaining proceeds to buy two October 60 calls at 3
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points each. Thus, it is sometimes possible for the speculator to recoup his entire
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original investment and still increase the number of calls outstanding by rolling up.
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Once this has been done, the October 60 calls will represent pure profits, whatever
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their price. The buyer who "rolls up" in this rrwnner is essentially speculating with
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someone else's money. He has put his own money back in his pocket and is using
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accrued profits to attempt to realize further gains. At expiration, this tactic would
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perform best if XYZ increased by a substantial amount. This tactic turns out to be the |