Options2 - Introduction to Options II By Dr Fernando Diz...

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Unformatted text preview: Introduction to Options II By Dr. Fernando Diz Hedge Strategies ❚ Hedge or covered strategies involve positions in both the underlying security and one or more options . Covered call writing ❚ It involves writing calls against an underlying portfolio of the underlying security. ❚ For example, let’s say you have a long position (own) 100 shares of IBM, trading at $115/share. Covered call writing ❚ Suppose the Feb 115 call option quoted bid price is $6.30 per share, that is $630 per contract. ❚ What would be the profit diagram at expiration of a strategy that sells one call option? Covered call writing ❚ The profit of this strategy is equal to: ❚ Profit from holding 100 shares of the stock PLUS ❚ Profit from writing 1 call on those shares. Profit graph for a covered call at expiration Profits of C overed C all W ritting E=115, C=6.3, S=115-10000-8000-6000-4000-2000 2000 4000 6000 30 50 70 90 110 130 150 170 Covered Call Profit: $630 Long Stock Profits Written Call Profits E=115 The covered call: ❚ Reduces the potential loss from owning the stock by the amount of the premium received. ❚ Limits the upside potential since it has a constant profit. The covered call: ❚ Break-even point is equal to the stock price at purchase time minus the call premium: S-C. ❚ Maximum profit potential is equal to: E- S+C The covered call: ❚ Does the profit diagram look like some other one? ❚ The covered call has a constant profit when the stock is above its original purchase price. The covered call: ❚ The covered call loses money when the stock price goes up below its original purchase price by the amount of the premium. ❚ So what does the profit diagram of a covered call look like? A written PUT!!! Written Put Profits E=115, P=6.3-5000-3000-1000 1000 50 100 150 Stock Price at Expiration E:115 Aggressive or defensive? Covered call write with in the money (defensive) and out of the money (aggresive) options-1000-800-600-400-200 200 400 600 35 40 45 50 55 60 65 70 75 C1 = 8, K=40 C2 = 1, K=50 Return calculation ❚ Example: ❚ Buy 500 shares of XYZ @ 43, ❚ Write 5 XYZ July 45 calls @ 3....
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This note was uploaded on 02/09/2010 for the course FIN 459 taught by Professor Yildary during the Spring '07 term at Syracuse.

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Options2 - Introduction to Options II By Dr Fernando Diz...

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