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Peter, your options comments here are very knowledgeable and helpful, however I disagree with your statement characterizing puts as "hedging" long positions. This just isn't so, in the classical sense. You do reduce your cost basis on your long by taking in put premiums,but you increase or de-hedge your risk if the stock declines, because you are long twice as much if it gets put to you. The risks to selling calls are of a different quality, that of lost opportunity to participate in the entire upside. The risk to the downside on calls, and you correctly point out there is some, is that you continue to hold the stock during a bad decline because the calls won't drop as much as the stock's price. Another point made by our MBA candidate friend here about time value didn't mention another component of option value, leverage. That's why the 12.5 calls are more than 2.5 plus the price of the 10.0's. You can buy more of the 12.5's per investment dollar , thus getting more leverage. Also, if Brad continues to hold the 7.5's, he loses the time value going forward, but he gains the time value of the money it would cost to own the stock, plus the downside protection of lower capital at risk. |
