26 lines
1.8 KiB
Plaintext
26 lines
1.8 KiB
Plaintext
CHAPl'ER 2
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Covered Call Writing
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Covered call writing is the name given to the strategy by which one sells a call option
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while simultaneously owning the obligated number of shares of underlying stock.
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The writer should be mildly bullish, or at least neutral, toward the underlying stock.
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By writing a call option against stock, one always decreases the risk of owning the
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stock. It may even be possible to profit from a covered write if the stock declines
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somewhat. However, the covered call writer does limit his profit potential and there
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fore may not fully participate in a strong upward move in the price of the underlying
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stock. Use of this strategy is becoming so common that the strategist must under
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stand it thoroughly. It is therefore discussed at length.
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THE IMPORTANCE OF COVERED CALL WRITING
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COVERED CALL WRITING FOR DOWNSIDE PROTECTION
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Example: An investor owns 100 shares of XYZ common stock, which is currently sell
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ing at $48 per share. If this investor sells an XYZ July 50 call option while still hold
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ing his stock, he establishes a covered write. Suppose the investor receives $300 from
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the sale of the July 50 call. If XYZ is below 50 at July expiration, the call option that
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was sold expires worthless and the investor earns the $300 that he originally received
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for writing the call. Thus, he receives $300, or 3 points, of downside protection. That
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is, he can afford to have the XYZ stock drop by 3 points and still break even on the
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total transaction. At that time he can write another call option if he so desires.
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Note that if the underlying stock should fall by more than 3 points, there will be
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a loss on the overall position. Thus, the risk in the covered writing strategy material
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izes if the stock falls by a distance greater than the call option premium that was orig
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inally taken in.
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