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Strategies & Market Trends : Point and Figure Charting

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To: Lucretius who wrote (2811)	5/5/1998 8:22:00 PM
From: Ms. X	of 34810

A STOCK BAND-AID -DWA Today we thought we would discuss a band-aid strategy for those who may have seen one of their stocks perform poorly. While there are a number of stocks which have both good technical and fundamental outlooks, not all perform as you would like them to. Suppose you bought 100 shares of our old favorite, XYZ Corp., at $35. The technical and fundamental pictures were positive and a move to $45 was expected. However, instead of moving to $45, XYZ declined to $25. If the fundamentals of XYZ have not changed and you still intend to hold the stock, there is a way to attempt to make this loss more manageable. Consider the following: You Buy 1 XYZ January 25 call at 5 and Sell 2 XYZ January 30 calls at 2 1-2 which Equals a gross cash outlay which is 0 You have just constructed what can be called a covered 2:1 ratio write. In other words, you now have a covered write and a bull spread. One of the January 30's which was sold is covered by the January 25 call that was bought, creating the bull spread and the other January 30 call sold is covered by the 100 shares of XYZ you currently hold. In this example the investor is only required to pay transactional fees and must execute the trade in a margin account. Now suppose the stock appreciated to 30 by the third Friday in January, the expiration date. The January 25 call purchased would be worth 5 points and the 2 January 30 calls would expire worthless. The end result is that you have lowered your breakeven point to 30 from 35. Although you will not participate in any gains above 30, you have reduced the breakeven point and increased the probability of reaching your new breakeven price. The original purchase of XYZ stock has still resulted in a loss but the loss is more manageable. In other words, you will break even if the stock rises to $30 with this strategy even though the stock is down over 14% from your original purchase price. You have made the loss more manageable.

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