Description
This is a useful
strategy for a stock
investor who wants
to start to accumulate
a position in XYZ
at current levels.
For example, an
investor thinks
that XYZ is "bottoming"
and wants to buy
200 shares. Although
confident, the investor
wants to only buy
1/2 now in case
XYZ moves lower.
When to use
Even though it
contain only 1/2
of the 200 XYZ shares
that the investor
wishes to accumulate,
it is important
to remember the
downside risks inherent
in any stock position.
Usually, the options
are selected so
that the Call Spread
is established for
a small debit or
even a credit (buying
1, writing 2).
Risk/Reward
Characteristics
The spread's
maximum profit potential
is reached at or
above the striking
price of the written
Calls (65) at expiration.
Because stock investor
ownership exists,
the downside risk
can be large if
XYZ has a large
decline. Depending
on the initial price
of the Call spread,
this strategy's
P&L can approach
that of a 200 share
position if XYZ
is at $65 at expiration!
Thus, the investor
can have nearly
the same profit
at $65 with only
100 shares!
Break-even
Point: Stock
Price + spread debit
(or minus spread
credit).
Time Decay:
If XYZ is near the
strike price of
the two written
Calls (65), profits
from decay accelerate
most rapidly over
time. If XYZ stays
near $60, profits
from decay of the
65 Calls offset
loses on the 60
Call. As expiration
approaches, the
spread's price becomes
mostly a function
of the price of
the 60 Call.
Volatility:
An increase in volatility
is a negative. The
impact will depend
of time left until
expiration and the
price of XYZ relative
to the two strike
prices. Because
of this, it is important
that the implied
volatilities of
XYZ's options be
high enough to allow
the spread to be
established for
near zero.
Assignment
Risk: The investor
must continuously
monitor XYZ for
possible assignment
if the 65 Calls
become in-the-money
prior to their expiration.
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