35 lines
2.3 KiB
Plaintext
35 lines
2.3 KiB
Plaintext
during this two-month period—not to short the stock. Because equity
|
||
options are American exercise and can be exercised/assigned any time from
|
||
the moment the call is sold until expiration, a short stock position cannot
|
||
always be avoided. If assigned, the short stock position will extend Sam’s
|
||
period of risk—because stock doesn’t expire. Here, he will pay one
|
||
commission shorting the stock when assignment occurs and one more when
|
||
he buys back the unwanted position. Many traders choose to close the naked
|
||
call position before expiration rather than risk assignment.
|
||
It is important to understand the fundamental difference between buying
|
||
calls and selling calls. Buying a call option offers limited risk and unlimited
|
||
reward. Selling a naked call option, however, has limited reward—the call
|
||
premium—and unlimited risk. This naked call position is not so much
|
||
bearish as not bullish . If Sam thought the stock was going to zero, he
|
||
would have chosen a different strategy.
|
||
Now consider a covered call example:
|
||
Buy 100 shares TGT at $49.42
|
||
Sell 1 TGT October 50 call at 1.45
|
||
Unlimited and risk are two words that don’t sit well together with many
|
||
traders. For that reason, traders often prefer to sell calls as part of a spread.
|
||
But since spreads are strategies that involve multiple components, they have
|
||
different risk characteristics from an outright option. Perhaps the most
|
||
commonly used call-selling spread strategy is the covered call (sometimes
|
||
called a covered write or a buy-write ). While selling a call naked is a way
|
||
to take advantage of a “not bullish” forecast, the covered call achieves a
|
||
different set of objectives.
|
||
After studying Target Corporation, another trader, Isabel, has a neutral to
|
||
slightly bullish forecast. With Target at $49.42, she believes the stock will
|
||
be range-bound between $47 and $51.50 over the next two months, ending
|
||
with October expiration. Isabel buys 100 shares of Target at $49.42 and
|
||
sells 1 TGT October 50 call at 1.45. The implications for the covered-call
|
||
strategy are twofold: Isabel must be content to own the stock at current
|
||
levels, and—since she sold the right to buy the stock at $50, that is, a 50
|
||
call, to another party—she must be willing to sell the stock if the price rises
|
||
to or through $50 per share. Exhibit 1.4 shows how this covered call
|
||
performs if it is held until the call expires. |