35 lines
2.3 KiB
Plaintext
35 lines
2.3 KiB
Plaintext
Cl,apter 4: Other Call Buying Strategies 119
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the short seller can cover his short by exercising the long call and buying stock at 40.
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Thus, the maximum risk that the short seller can incur in this example is the 3 points
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paid for the call. Table 4-1 and Figure 4-1 depict the results at expiration from uti
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lizing this strategy. Commissions are not included. Note that the break-even point is
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37 in this example. That is, if the stock drops 3 points, the protected short sale posi
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tion will break even because of the 3-point loss on the call. The short seller who did
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not spend the extra money for the long call would, of course, have a 3-point profit at
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37. To the upside, however, the protected short sale outperforms a regular short sale
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if the stock climbs anywhere above 43. At 43, both types of short sales have $300 loss
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es. But above that level, the loss would continue to grow for a regular short sale, while
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it is fixed for the short seller who also bought a call. In either case, the short seller's
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risk is increased slightly by the fact that he is obligated to pay out the dividends on
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the underlying stock, if any are declared.
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A simple formula is available for determining the maximum amount of risk
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when one protects a short sale by buying a call option:
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Risk = Striking price of purchased call + Call price - Stock price
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Depending on how much risk the short seller is willing to absorb, he might want to
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buy an out-of-the-money call as protection rather than an at-the-money call, as was
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shown in the example above. A smaller dollar amount is spent for the protection
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when one buys an out-of-the-money call, so that the short seller does not give away
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as much of his profit potential. However, his risk is larger because the call does not
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start its protective qualities until the stock goes above the striking price.
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Example: With XYZ at 40, the short seller of XYZ buys the July 45 call at ½ for pro
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tection. His maximum possible loss, if XYZ is above 45 at July expiration, would be
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TABLE 4-1.
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Results at expiration-protected short sale.
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XYZ Price at Profit Call Price at Profit Total
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Expiration on XYZ Expiration on Call Profit
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20 +$2,000 0 -$ 300 +$1,700
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30 + 1,000 0 - 300 + 700
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37 + 300 0 - 300 0
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40 0 0 - 300 300
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50 - 1,000 10 + 700 300
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60 - 2,000 20 + 1,700 300 |