Description
The investor
writing Call options
should firmly believe
that XYZ is not
going up! XYZ doesn't
have to go down,
but it most definitely
cannot go up. This
is because the strategy's
break-even point
at expiration is
a certain distance
above the then current
stock price. Thus,
depending on the
option's strike
price, writing Call
options can be a
viewed as a neutral
to bearish strategy.
Writing Calls:
Why?
Writing uncovered
("naked") Call options
is a strategy with
very high risk for
a small potential
return. Given this
obvious imbalance,
why would a prudent
investor wishing
to preserve and
build his or her
capital write Calls?
- Unaware of less risky "bearish" strategies.
- Strongly believes XYZ "can't go any higher," and therefore, blind to the potential risks.
- Time Decay.
Risk/Reward
Characteristics
Break-even
Point: At expiration,
the break-even point
(B.E.) is equal
to the strike price
of the Call option
plus the Call option's
premium. Before
expiration, the
break-even point
is lower.
Profit:
Profits are limited
no matter how large
the decline in XYZ.
Loss:
Losses are unlimited!!
Time Decay:
A Call option's
premium consists
of both intrinsic
value (if any) plus
time value. As time
passes, the time
value portion of
the Call erodes
(i.e., decays).
At expiration, the
Call's value will
equal its intrinsic
value.
Changes in
implied Volatility:
Changes in the option's
implied volatility
has an effect on
the "time value"
portion of an option's
premium.
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