38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
Chapter 6: Ratio Call Writing 159
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Example: The initial position again consists of buying 100 XYZ at 49 and selling two
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October 50 calls at 6. If XYZ then rose to 60, the following prices might exist: XYZ,
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60; XYZ October 50, 11; and XYZ October 60, 6.
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The ratio writer could thus roll this position up to reestablish a neutral profit
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range. If he bought back the two October 50 calls, he would take a 5-point loss on
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each one for a net loss on the calls of 10 points. This would effectively raise his stock
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cost by 10 points, to a price of 59. The rolled-up position would then be long 100 XYZ
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at 59 and short 2 October 60 calls at 6. This new, neutral position has a profit range
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of 47 to 73 at October expiration.
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In both of the examples above, the writer could have closed out the ratio write
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at a very small profit of about 1 point before commissions. This would not be advis
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able, because of the relatively large stock commissions, unless he expects the stock to
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continue to move dramatically. Either rolling up or rolling down gives the writer a
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fairly wide new profit range to work with, and he could easily expect to make more
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than 1 point of profit if the underlying stock stabilizes at all.
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Having to take rolling defensive action immediately after the position is estab
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lished is the most detrimental case. If the stock moves very quickly after having set
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up the position, there will not be much time for time value premium erosion in the
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written calls, and this will make for smaller profit ranges after the roll is done. It may
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be useful to use technical support and resistance levels as keys for when to take
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rolling action if these levels are near the break-even points and/or striking prices.
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It should be noted that this method of defensive action - rolling at or near strik
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ing prices - automatically means that one is buying back little or no time premium
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and is selling the greatest amount of time premium currently available. That is, if the
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stock rises, the call's premium will consist mostly of intrinsic value and very little of
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time premium value, since it is substantially in-the-money. Thus, the writer who rolls
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up by buying back this in-the-money call is buying back mostly intrinsic value and is
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selling a call at the next strike. This newly sold call consists mostly of time value. By
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continually buying back "real" or intrinsic value and by selling "thin air" or time value,
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the writer is taking the optimum neutral action at any given time.
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If a stock undergoes a dramatic move in one direction or the other, the ratio
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writer will not be able to keep pace with the dramatic movement by remaining in the
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same ratio.
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Example: If XYZ was originally at 49, but then undergoes a fairly straight-line move
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to 80 or 90, the ratio writer who maintains a 2:1 ratio will find himself in a deplorable
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situation. He will have accumulated rather substantial losses on the calls and will not
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be able to compensate for these losses by the gain in the underlying stock. A similar |