Trading Strategies Profit Making Techniques For Stock_6

Ratio Covered Call Writing 149 one direction to create a market exposure, and you lose money because of this exposure. In the final analysis, it is probably better to adjust whenever neces-sary and pay the extra commissions as the cost of not exposing yourself to market risk. The key to the answer to this question is the cost of your commissions versus the price risk of a change in the delta. If the Option Is About to Expire You are faced with several decisions if your calls are about to expire. The time premium will have essentially vanished. There is no desirability to holding a short call if the time premium is gone. You should either liquidate the trade or roll forward. The decision is largely based on the premium lev-els of the next contract month. If premium levels are high, then you should consider rolling forward. If they are low, you should consider doing a ratio covered call writing program against another instrument. In essence, the decision to roll forward is exactly the same as the decision to initiate a new position. Write Against a Convertible Security It is often more profitable to write calls against convertible securities. The most common convertible security is the convertible bond, although con-vertible preferreds and warrants are also candidates. (A complete discus-sion of using convertibles is included in Chapter 10. That discussion as-sumes that only the equivalent of one call will be written. To adapt that section to ratio covered call writing, take the analysis in that section but adjust for the delta.) C H A P T E R 12 Naked Put Writing Strategy Naked Put Writing Price Action Bullish Implied Time Volatility Decay Decreasing Helps Helps Profit Gamma Potential Hurts Limited Risk Unlimited STRATEGY Naked put writing is selling a put without owning the underlying instru-ment (UI). If your portfolio consisted of only a short OEX put, you would be short a naked put. Naked put writing is a bullish strategy. Put writers want the price of the UI to rise so they can buy back the put at a lower price. The best situation foranakedputwriterisfortheUIpricetomoveabovetheput’sstrikeprice at expiration, thus rendering the put worthless. The naked put writer will have captured all of the premium as profit. Figure 12.1 shows the option chart for a naked put write. Notice that the naked put write has a limited profit potential yet un-limited loss potential. However, some studies have suggested that over 70 percent of options expire worthless. The choice between shorting a naked put or buying the UI is based on several criteria. Look at the situation at expiration. In terms of price 151 152 3 2 1 0 −1 −2 −3 −4 −5 −6 −7 FIGURE 12.1 OPTION STRATEGIES Price of Underlying Instrument Naked Put Write action, the naked put is superior if the UI price is anywhere from the break-even point (discussed later) up to the strike price plus the put premium. Above that level, the long UI is superior. In other words, a very bullish outlook is better served by buying the UI, whereas a less bullish outlook is better served by selling the naked put. The situation before expiration is different. If you intend to actively manage your naked puts, then selling naked puts can be as attractive as buying the UI. The use of naked put writes as a substitute for buying the UI requires active management to mitigate, though not eliminate, the addi-tional risk. The form of active management is detailed throughout the rest of this chapter. One disadvantage of selling a put is that you are liable for dividend or interest payments, if applicable. The payment of dividends or interest causes the put to gain an equivalent amount in value, and thus reduce the profitability. An advantage of the naked put is that time is on the side of the naked put seller. As the option nears expiration, the time premium on the put evaporates and reduces the value of the put. EQUIVALENT STRATEGY An essentially equivalent strategy can be created by being long the UI and selling a call. It is unlikely that you will want to buy the UI and sell the call if you can simply sell the put. Selling the put is easier to execute and will cost less in commissions. The only time the equivalent strategy makes sense is if you already have one of the two legs on and want to change the character of the trade. Naked Put Writing 153 Suppose you are very bullish and buy the UI. Later, you decide the mar-ket is not as bullish and might even slump temporarily. This is the type of situation where you may initiate a synthetic naked put write. RISK/REWARD Net Investment The net investment is the margin required by the broker to carry the po-sition. Each exchange has different rules for devising the margin require-ments for the naked put write, and each broker can then boost the margin to a higher level than specified by the exchanges. Break-Even Point The break-even point at expiration is equal to the strike price minus the put premium. For example, if the strike is $50 and the put premium is $3, then the price of the UI cannot be less than $47 at the expiration of the put. Profit Potential The maximum profit potential is the premium received when the put is sold. This will occur only if the price of the UI is higher than the strike price at expiration. The reason that the maximum profit potential is only reached at expiration is that the option will always have time premium up to the last minutes of trading. You, therefore, have to let the option expire before the maximum profit potential can be reached. The naked put will also profit at expiration if the price of the UI lies between the strike price and the strike price minus the put premium. The rule in this case is: Profit = Put premium −(strike price +UI) Before expiration, the naked put will be making money if the UI price has rallied since initiating the naked put write, assuming all other factors remain the same. The profit (or loss) can be estimated by the delta of the option. For example, if you sold an option for $5 with a delta of 0.50, then the option will be close to $3 if the UI price has jumped $4. Note that deltas change as the UI price and implied volatility change. This means that you can only estimate the future value of the option, not pinpoint it precisely. ... - tailieumienphi.vn