37 lines
2.5 KiB
Plaintext
37 lines
2.5 KiB
Plaintext
396 Part Ill: Put Option Strategies
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In summary, this is a position with tremendous, even dangerous, leverage.
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In-the-Money Covered Call Write. The situation is slightly different if the
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option is in-the-money to begin with. The above margin requirements actually don't
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quite accurately state the case for a margined covered call write. When a covered call
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is written against the stock, there is a catch: Only 50% of the stock price or the strike
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price, whichever is less, is available for "release." Thus, one will actually be required
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to put up more than 50% of the stock price to begin with.
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Example: XYZ is trading at 50, and there is a 2-year LEAPS call with a strike price
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of 30, selling for 25 points. One might think that the requirement for a covered call
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write would be zero, since the call sells for 50% of the stock price. But that's not the
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case with in-the-money covered calls.
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Margin requirement:
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Buy stock: 50 points
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Less option proceeds -25
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Less margin release* -15*
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Net requirement: 10 points
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* 50% of the strike price or 50% of stock price, whichever is less.
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This position still has a lot ofleverage: One invests 10 points in hopes of making 5, if
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the stock is called away at 30. One also would have to pay interest on the 15-point
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debit balance, of course, for the two-year duration of the position. Furthermore,
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should the stock fall below the strike price, the broker would begin to require main
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tenance margin.
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Note that the above "formula" for the net requirement works equally well for
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the out-of-the-money covered call write, since 50% of the stock price is always less
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than 50% of the strike price in that case.
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To summarize this "free ride" strategy: If one should decide to use this strate
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gy, he must be extremely aware of the dangers of high leverage. One must not risk
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more money than he can afford to lose, regardless of how small the initial investment
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might be. Also, he must plan for some method of being able to make the margin pay
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ments along the way. Finally, the in-the-money alternative is probably better, because
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there is less probability that maintenance margin will be asked for.
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SELLING UNCOVERED LEAPS
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Uncovered option selling can be a viable strategy, especially if premiums are over
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priced. LEAPS options may be sold uncovered with the same margin requirements
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as short-term options. Of course, the particular characteristics of the long-term
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option may either help or hinder the uncovered writer, depending on his objective. |