Band-Aids For Calls
We have previously discussed closing out covered write positions that have moved in-the-money and if the returns justify doing so. We have recently seen the markets sell off from their highs and the NYSE Bullish Percent drop below the oversold 30% level. Those who purchased calls a month ago may have losses because of that decline. If so, then they may want to consider the following band-aid strategy. Options often give you a way to improve your position. Of course, we are assuming your thoughts on the stock have not changed, that you still like the stock fundamentally and technically and believe it will still rally. If this is not the case, then you should bite the bullet, close out the position and take the loss.
The band-aid strategy we are referring to is turning your long call positions into bull spreads. By doing this, you will lower your breakeven price and improve your position. What we want to do is sell twice as many of the calls you currently own and then purchase the same number of calls as your originally bought but at a lower strike price. For example, suppose you bought 5 XYZ January 30 calls at $4 back in early July. The stock has declined and the calls are now $2 1-8 with the stock trading below $26. You can sell those 5 calls and an additional 5 calls (to total 10) and with the proceeds, purchase 5 January 25 calls at $4 1-4. Your new position is now long 5 January 25 calls and short 5 January 30 calls, which is a bull spread. You want to do this spread for as little a debit as possible. The debit in this example, not using commissions, was zero. Now, if XYZ rallies to $30 by expiration, the January 30 calls will expire worthless while the January 25 calls will be worth $5. You see a net profit of $1. Granted, commissions will put a dent in your profits but that beats the four-point loss you will have at expiration if you do nothing and the stock is then 30. If you have a client who faces this situation, then you can present him or her with a viable solution to the problem. He or she may be ready to take some action.
Hewlett-Packard Company (HPQ - $47.10) Option Symbol - HPQ AI Buy the January 45.00 calls at 5.40 Stop loss of 43.00
Capital One Financial Corporation (COF - $68.69) Option Symbol - COF MO Buy the January 75.00 puts at 9.25 Stop loss of 74.00
Hercules Incorporated (HPC - $19.55) Option Symbol - HPC LD Sell the December 20.00 calls at 1.60
Investment for 500 shares Annualized Called Return Annualized Static Return Downside Protection
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