Tài chính doanh nghiệp - Chapter 3: Basic option strategies: covered calls and protective puts

© 2004 South-Western Publishing1Chapter 3Basic Option Strategies: Covered Calls and Protective Puts2OutlineUsing options as a hedgeUsing options to generate incomeProfit and loss diagrams with seasoned stock positionsImproving on the market3Using Options as A HedgeIntroductionProtective putsUsing calls to hedge a short positionWriting covered calls to protect against market downturns4IntroductionHedgers transfer unwanted risk to speculators who are willing to bear itE.g., insuring a homeInsurance that expires without a claim does not constitute a waste of money5Protective PutsDefinitionMicrosoft exampleLogic behind the protective putSynthetic options6DefinitionA protective put is a descriptive term given to a long stock position combined with a long put positionInvestors may anticipate a decline in the value of an investment but cannot conveniently sell7Microsoft ExampleAssume you purchased Microsoft for $28.51Stock price at option expirationProfit or loss ($)028.5128.518Microsoft Example (cont’d)Assume you purchased a Microsoft APR 25 put for $1.10 Stock price at option expiration01.1023.9023.90259Microsoft Example (cont’d)Construct a profit and loss worksheet to form the protective put:Stock Price at Option Expiration0515253040Long stock @ $28.51-28.51-23.51-13.51-3.511.4911.49Long $25 put @ $1.1023.9018.908.90-1.10-1.10-1.10Net-4.61-4.61-4.61-4.610.3910.3910Microsoft Example (cont’d)The worksheet shows thatThe maximum loss is $4.61The maximum loss occurs at all stock prices of $25 or belowThe put breaks even somewhere between $25 and $30 (it is exactly $29.61)The maximum gain is unlimited11Microsoft Example (cont’d)Protective put Stock price at option expiration04.612529.6112Logic Behind the Protective PutA protective put is like an insurance policyYou can choose how much protection you wantThe put premium is what you pay to make large losses impossibleThe striking price puts a lower limit on your maximum possible lossLike the deductible in car insuranceThe more protection you want, the higher the premium you are going to pay13Logic Behind the Protective Put (cont’d)Insurance Policy Put OptionPremium Time PremiumValue of Asset Price of StockFace Value Strike PriceDeductible Stock Price Less Strike PriceDuration Time Until ExpirationLikelihood of Loss Volatility of Stock14Synthetic OptionsThe term synthetic option describes a collection of financial instruments that are equivalent to an option positionA protective put is an example of a synthetic call15Using Calls to Hedge A Short PositionIntroductionShort saleMicrosoft example16IntroductionCall options can be used to provide a hedge against losses resulting from rising security pricesCall options are particularly useful in short sales17Short SaleInvestors can make a short saleThe opening transaction is a saleThe closing transaction is a purchaseShort sellers borrow shares from their brokersClosing out a short position is called covering the short position18Short Sale (cont’d)A short sale is like buying a putMany investors prefer the put The loss is limited to the option premiumBuying a put requires less capital than margin requirements19Microsoft ExampleAssume you short sold Microsoft for $28.51Stock price at option expirationProfit or loss ($)028.5128.51Maximum loss = unlimited20Microsoft Example (cont’d)Combining a short stock with a long call results in a long putAssume the purchase of an APR 35 call at $0.50 in addition to the short saleThe potential for unlimited losses is eliminated21Microsoft Example (cont’d)Construct a profit and loss worksheet to form the long put:Stock Price at Option Expiration0152528.513540Short stock @ $28.5128.5113.513.510-6.49-11.49Long 35 call @ $0.50-0.50-0.50-0.50-0.50-0.504.50Net28.0113.013.01-0.50-6.99-6.9922Microsoft Example (cont’d)Long put (short stock plus long call) Stock price at option expiration06.993528.0128.01The potential forunlimited loss is gone 23Writing Covered Calls to Protect Against Market DownturnsA call where the investor owns the stock and writes a call against it is called a covered callThe call premium cushions the lossUseful for investors anticipating a drop in the market but unwilling to sell the shares now24Writing Covered Calls to Protect Against Market Downturns A JAN 30 covered call on Microsoft @ $1.20; buy stock @ 28.51 Stock price at option expiration027.31302.6927.3125Using Options to Generate IncomeWriting calls to generate incomeWriting naked callsNaked vs. covered putsPut overwritingMicrosoft example26Writing Calls to Generate IncomeCan be very conservative or very risky, depending on the remainder of the portfolioAn attractive way to generate income with foundations, pension funds, and other portfoliosA very popular activity with individual investors27Writing Calls to Generate Income (cont’d)Writing calls may not be appropriate whenOption premiums are very lowThe option is very long-term28Writing Calls to Generate Income (cont’d)Writing a Microsoft Call Example It is now September 15, 2003. A year ago, you bought 300 shares of Microsoft at $22. Your broker suggests writing three JAN 30 calls @ $1.20, or $120.00 on 100 shares. 29Writing Calls to Generate Income (cont’d)Writing a Microsoft Call Example (cont’d) If prices advance above the striking price of $30, your stock will be called away and you must sell it to the owner of the call option for $30 per share, despite the current stock price. If Microsoft trades for $30, you will have made a good profit, since the stock price has risen substantially. Additionally, you retain the option premium. 30Writing Naked CallsVery risky due to the potential for unlimited losses31Writing Naked Calls(cont’d)Writing a Naked Microsoft Call ExampleThe following information is available:It is now September 15A SEP 35 MSFT call exists with a premium of $0.05The SEP 35 MSFT call expires on September 19Microsoft currently trades at $28.5132Writing Naked Calls(cont’d)Writing a Naked Microsoft Call Example (cont’d) A brokerage firm feels it is extremely unlikely that MSFT stock will rise to $35 per share in ten days. The firm decides to write 100 SEP 35 calls. The firm receives $0.05 x 10,000 = $500 now. If the stock price stays below $35, nothing else happens. If the stock were to rise dramatically, the firm could sustain a large loss. 33Naked vs. Covered PutsA naked put means a short put by itselfA covered put means the combination of a short put and a short stock position34Naked vs. Covered Puts (cont’d)A special short put is a fiduciary putRefers to the situation in which someone writes a put option and simultaneously deposits the striking price into a special escrow accountEnsures that the funds are present to buy the stock if the put owner exercises it35Naked vs. Covered Puts (cont’d)A short stock position would cushion losses from a short put: Short stock + short put short call36Put OverwritingPut overwriting involves owning shares of stock and simultaneously writing put options against these sharesBoth positions are bullish Appropriate for a portfolio manager who needs to generate additional income but does not want to write calls for fear of opportunity losses in a bull market37Microsoft ExampleAn investor simultaneously:Buys shares of MSFT at $28.51Writes an OCT 30 MSFT put for $238Microsoft Example (cont’d)Construct a profit and loss worksheet for put overwriting:Stock Price at Option Expiration0152528.2553035Buy stock @ $28.51-28.51-13.51-3.51-0.2551.496.49Write 30 put @ $2-28.00-13.00-3.000.2552.002.00Net-56.51-26.51-6.510.003.498.4939Microsoft Example (cont’d)Writing an OCT 30 put on MSFT @ $2; buy stock @ $28.51 Stock price at option expiration056.51303.49Breakeven point = 28.25540Profit and Loss Diagrams With Seasoned Stock PositionsAdding a put to an existing stock positionWriting a call against an existing stock position41Adding A Put to an Existing Stock PositionAssume an investorBought MSFT @ $22Buys an APR 25 MSFT put @ $1.10The stock price is currently $28.5142Adding A Put to an Existing Stock Position (cont’d)Stock Price at Option Expiration01025303540Long stock @ $22-22-12+3+8+13+18Long 25 put @ $1.10+23.90+13.90-1.10-1.10-1.10-1.10Net1.901.901.906.9011.9016.9043Adding A Put to an Existing Stock Position (cont’d)Protective put with a seasoned position Stock price at option expiration0251.9044Writing A Call Against an Existing Stock PositionAssume an investorBought MSFT @ $22Writes a JAN 30 call @ $1.20The stock price is currently $28.5145Writing A Call Against an Existing Stock Position (cont’d)Covered call with a seasoned equity positionStock price at option expiration020.80309.2020.8046Improving on the MarketWriting calls to improve on the marketInvestors owning stock may be able to increase the amount they receive from the sale of their stock by writing deep-in-the-money calls against their stock position47Writing Calls to Improve on the Market (cont’d)Writing Deep-in-the-Money Microsoft Calls Example Assume an institution holds 10,000 shares of MSFT. The current market price is $28.51. OCT 20 call options are available @ $8.62. The institution could sell the stock outright for a total of $285,100. Alternatively, the portfolio manager could write 100 OCT 20 calls on MSFT, resulting in total premium of $86,200. If the calls are exercised on expiration Friday, the institution would have to sell MSFT stock for a total of $200,000. Thus, the total received by writing the calls is $286,200, $1,100 more than selling the stock outright. 48Writing Calls to Improve on the Market (cont’d)There is risk associated with writing deep-in-the-money callsIt is possible that Microsoft could fall below the striking priceIt may not be possible to actually trade the options listed in the financial pages49Writing Puts to Improve on the MarketWriting puts to improve on the marketAn institution could write deep-in-the-money puts when it wishes to buy stock to reduce the purchase price