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.

LEAPS® Covered Write
Example: Biomedical Inc. (XYZ) is at 82. 100 shares of the stock would cost $8,200.
Outlook: Your outlook for the stock is bullish for the long term, but neutral in the short term. You decide to use a LEAP as a substitute for the stock, and to sell a short term out-of-the money call.
(Note: LEAPS do not pay dividends or confer voting rights; LEAPS also expire, unlike stock)
Possible strategy: LEAPS Covered Write.
Buy 1 January 2003 50 call at 37.25.
Sell 1 March 90 call at 3.75.
Net cost of 33.50, or $3,350.00.

*All values shown are at the time of March 2002 expiration.

Stock Change
XYZ @ March expiration
50 call value
(Remaining intrinsic value)
90 call value
(Expiring)
Position Value
Profit/(Loss)
+ 15.85%
95
$4,500.00
$500.00
$4,000.00
$650.00
+ 9.76%
90*
$4,000.00
$0.00
$4,000.00
$650.00
+ 1.83%
83.50***
$3,350.00
$0.00
$3,350.00
$0.00
+/- 0.0%
82**
$3,200.00
$0.00
$3,200.00
($150.00)
- 2.44%
80
$3,000.00
$0.00
$3,000.00
($350.00)
-39.02%
50****
$0.00
$0.00
$0.00
($3,350.00)

At March Expiration (03/16/02)
* Max Gain: $650.00; XYZ @ 90/higher (+9.76%)
** Unchanged: Unrealized loss of $150.00
*** Break-even: XYZ @ 83.50
**** Max Loss: $3,350; XYZ @ 50/lower (-39.02%)

Summary: Since the 50 call does not expire until January 2003, if XYZ is below 90 at March 2002 expiration, the short 90 call expires worthless, and the 50 call could be sold, exercised, or retained for unlimited upside potential above the break-even point (less commissions). If XYZ is above 90 at March expiration, and the short call is assigned, the long call could be sold or exercised, and the position closed out for a profit of $650.00 (less commissions) on a $3,350.00 investment. The 50 call could also be retained, and assignment could be filled by purchasing the stock in the market. Maximum risk is $3,350.00.


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