Here's an interesting strategy, suggested to me via e-mail and ... >And you didn't know nothin' about it, eh?
- We buy some stock, say,
**Sh**= 100**Sh**ares. - Suppose that we pay
**S**= $40 for the**S**hares, so our investment is**S *Sh**= $4000. - Now we write
**N**= 2 Call Option contracts, with a stri**K**e price of**K**= $30. - The
**C**all**p**remium for these options is, say,**Cp**= $11.00 so, selling the contracts, we get**100*N*Cp**= 100*2*11 = $2200 (where that 100 is because each contract involves 100 shares of stock).
Pay attention: - So far, we've spent
**S *Sh**= $4000 on stock and received**100*N*Cp**= $2200 for our Calls. - Our total out-of-pocket
**Cost**=**S*Sh - 100*N*Cp**= $4000 - $2200 = $1800. - Our options may be called at any stock price greater than
**K**= $30 (and will definitely be called if the stock price increases to**K + Cp**= $30 + $11 = $41 or above). - Suppose that, at some time in the future, the
**ST**ock increases to, say,**ST**= $45 and our options get called. - We now buy enough additional stock to cover the Call, namely
**100*N - Sh**= 200 - 100 = 100 shares. - Unfortunately, we must now buy these 100 additional shares at the current price, namely
**ST**= $45, at a cost of**(100*N - Sh)*ST**= $4500.
- So far it's cost us
**S*Sh - 100*N*Cp**= $1800 plus this additional cost of**(100*N - Sh)*ST**= $4500, for a total of**S*Sh - 100*N*Cp +(100*N - Sh)*ST**= $1800+$4500 = $6300. - We then sell the
**100*N**= 200 shares (called for by the options) at the strike price of**K**= $30, and that gives us**100*N*K**= 200*30 = $6000.
$6300 - $6000 = $300. Right. >And you're suggesting this strategy? I mean ...
The final Gain or Loss is:
which can be written:
(1) >And if the option isn't called? If the stock drops below ...?
- If the Option isn't called and the
**ST**ock price ends up, at expiry, at**ST**= $25, for example, then our**Sh**= 100 shares are worth just**Sh*ST**= 100*25 = $2500. - Remember our
**Cost**? It's**Cost**=**S*Sh - 100*N*Cp**= $1800. - Our Gain is then
**Sh*ST - Cost = Sh*ST - {S*Sh - 100*N*Cp}**= $2500 - $1800 = $700.
>It's about time you made some money!
(2) >And what if ...?
After you type in your parameters, the spreadsheet provides the Black-Scholes Call Premium, if you want to
play. >What's that "Winning Width" chart?
>Yeah, so, how do I get the spreadsheet?
Save Target.
>I assume the spreadsheet does what you did above, eh?
>Mamma mia! Am I supposed to follow all that stuff?
>But the picture of the spreadsheet says you lose if the stock goes up or down.
Altogether now:
Note the slope of the chart of Gain/Loss Slope = For our example, the slope changes from +100 to -100 at ST = $30 We'd like to arrange things so the range of winning stock prices is large.
>So do it!
>What's that T thing?
Uh ... T is the number of years to expiry ... for the option.
If we use Black-Scholes to calculate Stock Price,
we can run through a bunch of Strike Prices, K (as a percentage of the
current Stock Price) and see what's that Winning Width.
In fact ... >In fact, that's that extra chart on the spreadsheet, right? Right. You'll notice (from the picture of the spreadsheet), that although the Gain is a maximum when the Stock Price equals the Option's Strike Price, it also the gives the narrowest Winning Width.
>How 'bout a real, live example that ... Here's a real example ... an old one, taken from an old tutorial: The stock is selling for
If we pick appropriate The maximum Gain is $577 (with an initial Cost = $5423) ... if the stock ends up at the Strike Price of $60.
For the above real, live example, the option expires in Anyway, if we change to, say,
>Your example is from 1999. Can't you find a more recent ...?
Let's look at options with a Strike Price of $45, with a premium of, say, $11 and suppose that ... >Why not just show a picture? Here's a picture of the spreadsheet:
>You're assuming a 45% volatility? You kidding?
>Wait! Can I ask a question?
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