44 lines
2.8 KiB
Plaintext
44 lines
2.8 KiB
Plaintext
48 Part II: Call Option Strategies
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money covered write, it is necessary for the stock to rise in price in order for the return
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if exercised to be achieved. However, for an in-the-money covered write, the return if
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exercised would be attained even if the stock were unchanged in price at option expi
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ration. Thus, it is often advantageous to compute the return if unchanged - that is, the
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return that would be realized if the underlying stock were unchanged when the option
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expired. One can more fairly compare out-of-the-money and in-the-money covered
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writes by using the return if unchanged, since no assumption is made concerning stock
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price movement. The third important statistic that the covered writer should consid
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er is the exact downside break-even point after all costs are included. Once this down
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side break-even point is known, one can readily compute the percentage of downside
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protection that he would receive from selling the call.
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Example 1: An investor is considering the following covered write of a 6-month call:
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Buy 500 XYZ common at 43, sell 5 XYZ July 45 calls at 3. One must first compute the
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net investment required (Table 2-3). In a cash account, this investment consists of
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paying for the stock in full, less the net proceeds from the sale of the options. Note
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that this net investment figure includes all commissions necessary to establish the
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position. (The commissions used here are approximations, as they vary from firm to
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firm.) Of course, if the investor withdraws the option premium, as he is free to do,
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his net investment will consist of the stock cost plus commissions. Once the neces
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sary investment is known, the writer can compute the return if exercised. Table 2-4
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illustrates the computation. One first computes the profit if exercised and then
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divides that quantity by the net investment to obtain the return if exercised. Note
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that dividends are included in this computation; it is assumed that XYZ stock will pay
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$500 in dividends on the 500 shares during the life of the call. Moreover, all com
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missions are included as well - the net investment includes the original stock pur
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chase and option sale commissions, and the stock sale commission is explicitly listed.
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For the return computed here to be realized, XYZ stock would have to rise in
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price from its current price of 43 to any price above 45 by expiration. As noted ear
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lier, it may be more useful to know what return could be made by the writer if the
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stock did not move anywhere at all. Table 2-5 illustrates the method of computing the
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TABLE 2-3.
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Net investment required-cash account.
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Stock cost (500 shares at 43)
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Plus stock purchase commissions
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Less option premiums received
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Plus option sale commissions
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Net cash investment
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+
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$21,500
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320
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1,500
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+ 60
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$20,380 |