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Technology Stocks : Bay Networks (BAY)
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To: Srinivasan V S who wrote (2180)11/13/1996 9:22:00 PM
From: Mark The Trader   of 4270
 
Srini,
If the person main objective was to break even on the option trade in theory your strategy would only work if the stock were to trade down .
If Bay were to trade up the person could lose quite a bit on the trade.

Example:

Sell Jan20 call @ 3.5

Bay stock price on option expiration Jan 1997..$20....$25.....$30

Per call option:

Proceeds from sale of Jan 20 Bay call---------$3.5---$3.5----$3.5
cost to cover jan 20 call Option ---------------$0----($5.0)--($10.0)
Cost of March 25 call---------------------------(3.5)---(3.5)---(3.5)
Value of March 25 call on Option ex in Jan(est)--.50----2.00----6.00

Unrealized
Net Gain (loss) on Jan option expiration day-------.50 (3.00) (4.00)

The point I am trying to get across is if the stock goes up then by selling the call option with the lower strike price he risks losing more money than his original investment. The only way your strategy works is if the stock goes down to around 20 and then he can sell his whole position and break even. In the above example I assumed that the person would cover the Jan option and sell the March option. Also in my example If the stock is above 25 and he just covers the Jan option he now can even lose more money if the stock were to go down because he still has the March call option. A very important point , if the stock is above 20 he will be forced to cover the Jan option or he will have to sell the stock at 20 , and becuase he has no shares he will have to purchase them immediatly or risk being short the stock. The higher the stock price the more he loses. I hope this helps, if your really interested in options
there are many books that can explain in more detail then I have time to :-}

Mark
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