43 lines
2.6 KiB
Plaintext
43 lines
2.6 KiB
Plaintext
Chapter 25: LEAPS 397
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Uncovered Put Selling. Naked put selling is addressed first because, as a strat
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egy, it is equivalent to covered writing, and covered writing was just discussed. Two
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strategies are equivalent if they have the same profit picture at expiration. Naked put
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selling and covered call writing are equivalent because they have the profit picture
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depicted in Graph I, Appendix D. Both have limited upside profit potential and large
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loss exposure to the downside. In general, when two strategies are equivalent, one of
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the two has certain advantages over the other.
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In this case, naked put selling is normally the more advantageous of the two
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because of the way margin requirements are set. One need not actually invest cash
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in the sale of a naked put; the margin requirement that is asked for may be satisfied
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with collateral. This means the naked put writer may use stocks, bonds, T-bills, or
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money market funds as collateral. Moreover, the actual amount of collateral that is
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required is less than the cash or margin investment required to buy stock and sell a
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call. This means that one could operate his portfolio normally - buying stock, then
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selling it and putting the proceeds in a Treasury bill or perhaps buying another stock
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- without disturbing his naked put position, as long as he maintained the
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collateral requirement.
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Consequently, the strategist who is buying stock and selling calls should probably
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be selling naked puts instead. This does not apply to covered writers who are writing
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against existing stock or who are using the incremental return concept of covered writ
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ing, because stock ownership is part of their strategy. However, the strategist who is
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looking to take in premium to profit if the underlying stock remains relatively
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unchanged or rises, while having a modicum of downside protection ( which is the
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definition of both naked put writing and covered writing), should be selling naked
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puts. As an example of this, consider the LEAPS covered write discussed previously.
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Example: XYZ is selling at 50. The investor is debating between a 500-share covered
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write using 2-year LEAPS calls or selling five 2-year LEAPS puts. The January 50
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LEAPS call sells for 8½ and has two years of life, while the January 50 LEAPS put
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sells for 3½. Further assume that XYZ pays a dividend of $0.25 per quarter.
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The net investment required for the covered write is calculated as it was before.
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Net Investment Required - Covered Write
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Stock cost (500 shares @ 50)
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Plus stock commission
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Less option premiums received
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Plus option commissions
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Net cash investment
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+
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$25,000
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300
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- 4,250
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+ 100
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$21,150 |