41 lines
1.8 KiB
Plaintext
41 lines
1.8 KiB
Plaintext
184
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Example: The following prices exist:
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XYZ common, 49;
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XYZ April 50 call, 3; and
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XYZ April 35 call, 14.
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Part II: Call Option Strategies
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Since the deeply in-the-money call has no time premium, its purchase will perform
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much like the purchase of the stock until April expiration. Table 7-4 summarizes the
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profit potential from the covered write or the bull spread. The profit potentials are
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the same from a cash covered write or the bull spread. Both would yield a $400 prof
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it before commissions if XYZ were above 50 at April expiration. However, since the
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bull spread requires a much smaller investment, the spreader could put $3,500 into
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interest-bearing securities. This interest could be considered the equivalent of
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receiving the dividends on the stock. In any case, the spreader can lose only $1,100,
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even if the stock declines substantially. The covered writer could have a larger unre
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alized loss than that if XYZ were below 35 at expiration. Also, in the bull spread sit
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uation, the writer can "roll down" the April 50 call if the stock declines in price, just
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as he might do in a covered writing situation.
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TABLE 7-4.
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Results for covered write and bull spread compared.
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Maximum profit potential
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(stock over 50 in April)
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Break-even point
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Investment
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Covered Write:
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Buy XYZ and Sell
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April 50 Coll
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$ 400
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46
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$4,600
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Bull Spread:
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Buy XYZ April 35 Call and
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Sell April 50 Coll
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$ 400
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46
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$1,100
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Thus, the bull spread offers the same dollar rewards, the same break-even
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point, smaller commission costs, less potential risk, and interest income from the
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fixed-income portion of the investment. While it is not always possible to find a
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deeply in-the-money call to use as a "substitute" for buying the stock, when one does
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exist, the strategist should consider using the bull spread instead of the covered write. |