34 lines
2.0 KiB
Plaintext
34 lines
2.0 KiB
Plaintext
Gapter 2: Covered Call Writing 41
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do with it as he pleases. That income can represent a substantial increase in the
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income currently provided by the dividends on the underlying stock, or it can act to
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offset part of the loss in case the stock declines.
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For readers who prefer formulae, the profit potential and break-even point of a
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covered write can be summarized as follows:
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Maximum profit potential = Strike price Stock price + Call price
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Downside break-even point = Stock price - Call price
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QUANTIFICATION OF THE COVERED WRITE
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Table 2-1 and Figure 2-1 depict the profit graph for the example involving the XYZ
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covered write of the July 50 call. The table makes the assumption that the call is
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bought back at parity. If the stock is called away, the same total profit of $500 results;
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but the price involved on the stock sale is always 50, and the option profit is always
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$300.
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Several conclusions can be drawn. The break-even point is 45 (zero total prof
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it) with risk below 45; the maximum profit attainable is $500 if the position is held
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until expiration; and the profit if the stock price is unchanged is $300, that is, the cov
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ered writer makes $300 even if his stock goes absolutely nowhere.
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The profit graph for a covered write always has the shape shown in Figure 2-1.
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Note that the maximum profit always occurs at all stock prices equal to or greater
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than the striking price, if the position is held until expiration. However, there is
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downside risk. If the stock declines in price by too great an amount, the option pre
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mium cannot possibly compensate for the entire loss. Downside protective strategies,
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which are discussed later, attempt to deal with the limitation of this downside risk.
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TABLE 2-1.
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The XYZ July 50 call.
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XYZ Price Stock July 50 Call Call Total
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at Expiration Profit at Expiration Profit Profit
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40 -$ 800 0 +$300 -$500
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45 - 300 0 + 300 0
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48 0 0 + 300 + 300
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50 + 200 0 + 300 + 500
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55 + 700 5 - 200 + 500
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60 + 1,200 10 - 700 + 500 |