Strategies

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Weekly Strategy Discussion

The Weekly Strategy Discussion is designed to assist individuals in learning how options work and in understanding various options strategies. Options involve risk and are not suitable for all investors. The strategies discussed are for educational and illustrative purposes only, and should not be construed as an endorsement, recommendation or solicitation to buy or sell securities. Commissions, taxes and transaction costs are not included. Please contact a tax advisor for the tax implications involved in these strategies.

Covered call writing using In-the-Money LEAPS®

Situation:
You are long one (1) XYZ Jan (03) 50 LEAPS call for which you paid 48-3/16. XYZ has just announced a restructuring that will affect their revenues in the short term. XYZ stock has increased almost $10 since you bought the call, but today it is at 98-3/16, down 1-15/16 from the previous day's close. XYZ has a 52-wk high of 148-3/4 and a 52-wk low of 72-1/8.

Outlook:
You are Neutral to Moderately Bullish in the short term, looking to outperform in a flat XYZ market. You expect XYZ to return to strong revenues after one fiscal quarter (3 months) of restructuring.

Possible Strategy:
LEAPS "Covered Write" (actually a Diagonal Call Spread). Hold on to current LEAPS call and sell a June 100 call @ 8-7/8 against it.

*All values shown are at the time of expiration.

Stock Change
XYZ at exp.
Jan 50 call Value
June 100 call Value
Effective Cost of Position
Net Profit/(Loss)
17.10%
115
$6,500.00
$1,500.00
($3,931.25)
$1,068.75
10.90%
108-7/8
$5,887.50
$887.50
($3,931.25)
$1,068.75
1.80%
100*
$5,000.00
$0.00
($3,931.25)
$1,068.75
+/- 0%
98-3/16***
$4,818.75
$0.00
($3,931.25)
$887.50
-9.00%
89-5/16**
$3,931.25
$0.00
($3,931.25)
0
-13.40%
85
$3,500.00
$0.00
($3,931.25)
($431.25)

AT EXPIRATION (6/16/01)
* Max Gain: $1068.75 @ XYZ 100/higher (+1.8%)
** Break-even: XYZ @ 89-5/16 (- 9.1%)
*** Unchanged: Gain of $887.50
Max Loss: $3,931.25 (LEAPS cost of 48-3/16 less short call premium of 8-7/8).

In Short:
You already own the Jan (03) 50 LEAPS call. This strategy gives you limited downside protection on your LEAPS purchase (premium received on June calls $887.50) as well as profit potential in a flat market, with the tradeoff being that you give away all upside past 100. In the event the stock runs up past the short 100 call strike and you are assigned, you can do one of the following:

a)Go into the market to purchase the stock for delivery,
b)Sell your LEAP back and use the proceeds to help with the purchase of the stock to deliver,
c)Exercise your LEAPS at 50 and deliver the stock at 100.

Please note: As of January 29, 2001, all stocks listed on the New York Stock Exchange, and therefore all options listed on these stocks, will be quoted in decimals. However, stocks listed on the NASDAQ Stock Exchange, and their corresponding options, continue to be quoted in fractions. As the underlying instruments convert to decimal quotation, the options listed on these securities will also be quoted in dollars and cents. The Securities and Exchange Commission (SEC) has mandated a date of April 9, 2001 for equities to be quoted in decimals.

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