Description
A Covered Straddle
is the combination
of two other "bullish"
strategies - Covered
Call Write plus
Writing Puts. Both
options share the
same expiration
date as well as
the same striking
price. Note: Covered
Combinations differ
in that the two
options have different
striking prices.
When to use
An excellent
alternative for
stock investors.
The key is that
the stock investor
purchases only one-half
the amount of stock
that he or she would
normally be willing
to purchase. For
example, buying
100 shares of XYZ
and writing the
two options is a
lower risk investment
that the outright
purchase of 200
shares of XYZ. At
expiration, the
investor will have
either a $937.5
profit and no position
in XYZ stock or
own 200 shares of
XYZ for an average
price of $55.31!
Risk/Reward
Characteristics
Profit potential
is limited, but
greater than a Covered
Write. Maximum profit
equals Straddle
premium plus strike
price minus initial
stock price. Losses
are unlimited because
the investor could
end up with a long
stock position twice
the initial size.
Because of this
fact, the investor
must carefully consider
the initial size
of the spread!
Break-even
Point: (Stock
Price + Strike Price
- Straddle premium)/2
Time Decay:
Positive. Over time,
the time value portion
of both options
erodes (i.e., decays).
At expiration, only
one of the two can
be in-the-money
and equal to its
intrinsic value.
The other will expire
worthless!
Volatility:
Because this strategy
contains several
written options
(Call and Put),
a change in volatility
can have a large
impact on this spread.
If volatility increases,
both options increase
in price. Given
a decrease, both
written options
decrease in price.
Assignment
Risk: With two
written options,
the investor must
watch XYZ for possible
assignment on whichever
option is then currently
in-the-money. Of
the two possible
assignments, the
Put is the one that
should concern the
investors the most.
First, the investor's
stock position doubles
with the notice
of assignment. Secondly,
if XYZ has declined
enough to warrant
the Put exercise,
maybe the investor
should re-examine
his or her original
bullish opinion.
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