38 lines
2.8 KiB
Plaintext
38 lines
2.8 KiB
Plaintext
er 20: The Sale of a Straddle 303
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aracteristics of a covered call write are the same for the covered straddle write.
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There is limited upside profit potential and potentially large downside risk.
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Readers will remember that the sale of a naked put is equivalent to a covered
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call write. Hence, a covered straddle write can be thought of either as the equivalent
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of a 200-share covered call write, or as the sale of two uncovered puts. In fact, there
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•• some merit to the strategy of selling two puts instead of establishing a covered
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straddle write. Commission costs would be smaller in that case, and so would the ini
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tial investment required (although the introduction of leverage is not always a good
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tlting).
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The maximum profit is attained if XYZ is anywhere above the striking price of
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50 at expiration. The amount of maximum profit in this example is $800: the premi
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um received from selling the straddle, less the 1-point loss on the stock if it is called
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11way at 50. In fact, the maximum profit potential of a covered straddle write is quick
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ly computed using the following formula:
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Maximum profit = Straddle premium + Striking price - Initial stock price
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The break-even point in this example is 46. Note that the covered writing por
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tion of this example buying stock at 51 and selling a call for 5 points - has a break
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even point of 46. The naked put portion of the position has a break-even point of 46
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as well, since the January 50 put was sold for 4 points. Therefore, the combined posi
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tion - the covered straddle write - must have a break-even point of 46. Again, this
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observation is easily defined by an equation:
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B ak . Stock price + Strike price - Straddle premium re -even pnce =
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2
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Table 20-1 and Figure 20-1 compare the covered straddle write to a 100-share cov
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ered call write of the XYZ January 50 at expiration.
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The attraction for the covered call writer to become a covered straddle writer is
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that he may be able to increase his return without substantially altering the parame
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ters of his covered call writing position. Using the prices in Table 20-1, if one had
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decided to establish a covered write by buying XYZ at 51 and selling the January 50
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call at 5 points, he would have a position with its maximum potential return anywhere
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above 50 and with a break-even point of 46. By adding the naked put to his covered
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call position, he does not change the price parameters of his position; he still makes
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his maximum profit anywhere above 50 and he still has a break-even point of 46.
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Therefore, he does not have to change his outlook on the underlying stock in order
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to become a covered straddle writer.
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The investment is increased by the addition of the naked put, as are the poten
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tial dollars of profit if the stock is above 50 and the potential dollars of loss if the stock |