35 lines
2.3 KiB
Plaintext
35 lines
2.3 KiB
Plaintext
244 • The Intelligent Option Investor
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Clearly, the range of exposure for the $55-strike call is well above the
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BSM cone. The BSM cone is pointing downward because the dividend rate
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is 5 percent—higher than the risk-free rate. This means that BSM drift will
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be lower. In addition, because this is an old, mature, steady-eddy kind of
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company, the expected forward volatility is low. Basically, this is a perfect
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storm for a low option price.
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My suggestion is to either write calls on stocks you don’t mind de-
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livering to someone else—stocks for which you are very confident in the
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valuation range and are now at or above the upper bound—or simply to
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look for a portfolio of short-put/covered-call investments and treat it like
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a high-yield bond portfolio, as I described in Chapter 10 when explaining
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short puts. It goes without saying that if you think that a stock has a lot of
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unappreciated upside potential, it’s not a good idea to sell that exposure
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away!
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One other note about execution: as I have said, short puts and cov-
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ered calls are the same thing, but a good many investors do not realize this
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fact or their brokerages prevent them from placing any trade other than a
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covered call. This leads to a situation in which there is a tremendous sup-
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ply of calls. Any time there is a lot of supply, the price goes down, and you
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will indeed find covered calls on some companies paying a lot less than
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the equivalent short put. Because you will be accepting the same downside
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exposure, it is better to get paid more for it, so my advice is to write the put
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rather than the covered call in such situations.
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To calculate returns for covered calls, I carry out the following steps:
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1. Assume that you buy the underlying stock at the market price.
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2. Deduct the money you will receive from the call sale as well as
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any projected dividends—these are the two elements of your cash
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inflow—from the market price of the stock. The resulting figure is
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your effective buy price (EBP).
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3. Divide your total cash inflow by the EBP .
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I always include the projected dividend payment as long as I am writ-
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ing a short-tenor covered call and there are no issues with the company
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that would prevent it from paying the dividend. Owners of record have a
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right to receive dividends, even after they have written a covered call on the |