38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
164 Part II: Call Option Strategies
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Example: An investor places a "good until canceled" stop order to buy 100 shares of
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XYZ at 57 at the same time that he establishes the original position. If XYZ should
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get to 57, the stop would be set off and he would then own 200 shares ofXYZ and be
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short 2 calls. That is, he would have a 200-share covered write of XYZ October 50
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calls.
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To see how such an action affects his overall profit picture, note that his average
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stock cost is now 53; he paid 49 for the first 100 shares and paid 57 for the second 100
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shares bought via the stop order. Since he sold the calls at 6 each, he essentially has a
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covered write in which he bought stock at 53 and sold calls for 6 points. This does not
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represent a lot of profit potential, but it will ensure some profit unless the stock falls
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back below the new break-even point. This new break-even point is 47 - the stock
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cost, 53, less the 6 points received for the call. He will realize the maximum profit
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potential from the covered write as long as the stock remains above 50 until expira
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tion. Since the stock is already at 57, the probabilities are relatively strong that it will
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remain above 50, and even stronger that it will remain above 47, until the expiration
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date. If the buy stop order was placed just above a technical resistance area, this prob
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ability is even better.
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Hence, the use of a buy stop order on the upside allows the ratio writer to auto
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matically convert the ratio write into a covered write if the stock moves up too far.
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Once the stop goes off, he has a position that will make some profit as long as the
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stock does not experience a fairly substantial price reversal.
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Downside protective action using a sell stop order works in a similar manner.
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Example: The investor placed a "good until canceled" sell stop for 100 shares of
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stock after establishing the original position. If this sell stop were placed at 41, for
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example, the position would become a naked call writer's position if the stock fell to
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41. At that time, the 100 shares of stock that he owned would be sold, at an 8-point
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loss, but he would have the capability of making 12 points from the sale of his two
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calls as long as the stock remained below 50 until expiration. In fact, his break-even
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point after converting into the naked write would actually be 52 at expiration, since
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at that price, the calls could be bought back for 2 points each, or 8 points total prof
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it, to offset the 8-point loss on the stock. This action limits his profit potential, but
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will allow him to make some profit as long as the stock does not experience a strong
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price reversal and climb back above 52 by expiration.
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There are several advantages for inexperienced ratio writers to using this
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method of protection. First, the implementation of the protective strategies - buying
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an extra 100 shares of stock if the stock moves up, or selling out the 100 shares that
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are long if the stock moves down - is unemotional if the stop orders are placed at the |