35 lines
2.6 KiB
Plaintext
35 lines
2.6 KiB
Plaintext
158 Part II: Call Option Strategies
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FOLLOW-UP ACTION
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Aside from closing the position completely, there are three reasonable approaches to
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follow-up action in a ratio writing situation. The first, and most popular, is to roll the
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written calls up if the stock rises too far, or to roll down if the stock drops too far. A
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second method uses the delta of the written calls. The third follow-up method is to
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utilize stops on the underlying stock to alter the ratio of the position as the stock
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moves either up or down. In addition to these types of defensive follow-up action, the
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investor must also have a plan in mind for taking profits as the written calls approach
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expiration. These types of follow-up action are discussed separately.
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ROLLING UP OR DOWN AS A DEFENSIVE ACTION
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The reader should already be familiar with the definition of a rolling action: The cur
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rently written calls are bought back and calls at a different striking price are written.
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The ratio writer can use rolling actions to his advantage to readjust his position if the
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underlying stock moves to the edges of his profit range.
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The reason one of the selection criteria for a ratio write was the availability of
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both the next higher and next lower striking prices was to facilitate the rolling actions
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that might become necessary as a follow-up measure. Since an option has its great
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est time premium when the stock price and the striking price are the same, one
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would normally want to roll exactly at a striking price.
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Example: A ratio writer bought 100 XYZ at 49 and sold two October 50 calls at 6
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points each. Subsequently, the stock drops in price and the following prices exist:
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XYZ, 40; XYZ October 50, l; and XYZ October 40, 4.
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One would roll down to the October 40 calls by buying back the 2 October
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50's that he is short and selling 2 October 40's. In so doing, he would reestablish a
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somewhat neutral position. His profit on the buy-back of the October 50 calls
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would be 5 points each - they were originally sold for 6 - and he would realize a
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10-point gain on the two calls. This 10-point gain effectively reduces his stock cost
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from 49 to 39, so that he now has the equivalent of the following position: long 100
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XYZ at 39 and short 2 XYZ October 40 calls at 4. This adjusted ratio write has a
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profit range of 31 to 49 and is thus a new, neutral position with the stock currently
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at 40. The investor is now in a position to make profits if XYZ remains near this
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level, or to take further defensive action if the stock experiences a relatively large
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change in price again.
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Defensive action to the upside - rolling up -works in much the same manner. |