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Strategies & Market Trends : ThE WoNdErFuL wOrLd Of OpTiOnS
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To: RBane who wrote (283)2/24/1997 12:01:00 PM
From: Madpinto   of 308
 
R-I will assume you want to sell March options, so I do not need to discuss the consequences of the dividend. By writing puts in addition to your covered call position, you are just increasing the position you have on already. When selling puts, you have more leverage and require capital than covered call writing. This, however, is figured into the price of the option. The risk of covered call writing roughly equals the risk of selling puts. If you want the protection of an out of the money put for your short put position, you should want the same protection for your covered call position. Unless you already own the stock, you have to pay two commissions instead one. This can make selling puts an attractive alternate to writing covered calls. The public unjustly fears put selling more than covered call writing. To make a rough comparison between the two strategies, figure out how much premium you would collect if the stock did not move at all from the time you sold the options. Then subtract the difference in cash outlay between the two and multiply this times your interest rate. (This lets you know how much interest you could have earned if you had your money in an interest bearing account rather than tied up with stock and calls.) Subtract this amount from the premium derived from writing the calls. Then add in any dividends to the covered call premium. Let me give you an example.
GE trades at $106 and pays a $0.52 dividend with a X-div date of 3/4/97. The Mar 110 calls are 1 1/8 bid and the Mar 110 puts are 5 bid. 26 days to expiration. Interest rate 7%.
Write the calls once- If the stock does not more we would collect 1 1/8 in premium or $112.5. We must put up 1 $106 times 100 shs less the premium received. (106*100)-112.5=10,487.5. Multiply this number times the days to expiration (divided by days in the year) and your interest rate. In this case we have
26/364 *.07*10487.5= 52.4375 or about $52.44. Now add back in the dividend that will be paid before expiration (3/4) in the amount of $52 ($0.52*100). You collect a grand total of $112.06 (112.50 + 52.00 - 52.44)
Selling puts- Intrinsic value of the put is the strike less the stock or $4 in this case. We sell the put for $5 so the premium is $1. Multiply times 100 and we get $100.

Note- I did not include commissions. In this case an extra commission could make a real difference. Also, I assumed the money received from selling the put does not receive interest. Lastly, The stock would actually drop to $105 « after the X-div. This does not change the calculations.

Caution- This method has some flaws. Certain conditions may occur that invalidate this comparison. Use common sense. If the difference between the two scenarios widens to unusual proportions, then this comparison probably has not fully evaluated the circumstances correctly.
Mike
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