My (Herm) Response Hummm?
I have to think about what I'm trying to say. You paid $3 for the LEAP. Now,
being called out of a CC against the LEAP is handled differently by brokerages.
Some, will automatically exercise the LEAP and pay the CCer the strike price
without your input. Others, will put a notice in your email or phone call you to
advise you of the call and request delivery of the stock. So, you would give
directions to liquidate the LEAP by exercising and handling over the stock. Ask
them how they handle it before you begin such trading Rob. You are right about me
saying "keep the 3" which is not accurate. I have it stuck in my answer. If you are
called out at the $10 strike for the CCs and the LEAP is exercised to deliver the
stock to your CCer. Yes, with commissions you would be in the red. 1 3/8s is the
only true profit and that will be eroded by commissions and $3- $1.375=-$1 5/8s in
the hole. So, the longer one waits for a price increase in the LEAP (example
$10+$3) before completing the spread with the CC, the better the profit potential.
Going up several strike prices above your nut ($10+$3 in this example) would yield
a profit if you are called out. As you wrote, you saw with JPM how fast that LEAP
could increase PROVIDED you use the BB and RSI to make your entry. You
right! I said it wrong again. It is a fairly abstract conversation that not many folks
could explain. You have a very good grasp of the situation Rob. That why, I need
folks like you to put our heads together and nail this down to some understandable
language to avoid costly mistakes. Rob Replied: |From my recollection of
previous posts (long ago), |this is the reason why you must write the call for
|the strike price equal to your leap strike price plus |the premium paid for the
Leap-- to insure you receive |your premium (the price you paid for the Leap)
back. |Does this make sense? If you look at another way, if |you sell the LEAP
outright (and participate in the |increase of the LEAP) to satisfy your
obligation, you |are no longer covered in relation to the call you sold. | |You
continued: | |"If CS does pull back before the expiration date and |the CS
selling |price is below $10, the written CS July 10s CCs would |expire
|worthless and then you could write another round of |CCs or liquidate |the
appreciated CS long LEAP for say $9.50 - $9.75. |After all, the |CS stock
price was around $8.00+ when picked up the |CS LEAPs @3. |Today, the CS
LEAP is selling for $3.50 and the July |10s @ 1 1/2. |Of course, I can't predict
the exact future outcomes, |but, under the |conditions stated above that CS
LEAP would cost more |than $3 and |perhaps less than $4.25, so let's say
$3.75. Add to |the CC premie |$3.75 LEAP sold-$3 paid=$.75 profit
difference to add |to the 1 3/8s |for a total of 2 1/8s. Now, 2 1/8 divided by $3
|=70.8%. Again, we |are playing "what if" as an objective strategy |employing
some WINs rules." Rob States |This analysis I agree with, since you are not called
|out, so you keep the $1 3/8 plus any increase in the |value of your LEAP. You
participate in that Leap |increase since you are not obligated to use it to |fulfill your
covered call. | |In summary, I contend that if you get called out you |have a negative
return and if you do not, you have |the possibility of a 70% return. | |Sorry for this
discussion, but since I am planning on |using this strategy, I want to make sure I
understand |it fully. Herm's Final Point Hey, I'm glad you questioned what I said! I
was wrong on that part and it needed to be correct. I will now say as a rule that you
need to write a CC at a strike which equals net cost of LEAP plus + LEAP strike
price for the first round of CCs. Rob's Final Comments |Also, regarding my last
email to you, JPM 2001 Leaps |were selling for around $24 at that time, and
today |they are selling for $38 - not quite the double I had |indicated, but a
healthy return none the less for |less than a month time period! .
In trying to understand this better, it seems to me that if you own the LEAP, and have sold covered calls against that position....as Rob & Herm were talking about (backing up quite a ways here, guys...but am just trying to learn).....the key is not to get exercised
because if the stock has gone up....to the strike price on your CC's....your LEAP should have gone up also....at least some...and you may have a profit built in.....by buying back the CC, and selling the LEAP contracts. However, if they are too far out, they may not reflect the runup in price. |
