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Strategies & Market Trends : The Covered Calls for Dummies Thread -- Ignore unavailable to you. Want to Upgrade?

To: FaultLine who wrote (496)	5/10/2001 4:40:11 PM
From: dday	Respond to of 5205

Did some refresher work and had my explanation confirmed from an OCC contact. It works like this: I)) say you buy 1000 xyz @ 50 That cost you $50,000 (lets forget transaction costs for the sake of simplicity) That $50,000 could have been in a t-bill earning 4% interest. (again, stock pays no dividend for sake of simplicity). That interest for 1 day or 3 months is the cost of carry or 'time value' of the money you have tied up in the stock. Okay, that's the first part. II) I could also go long stock by creating a "synthetic position" using options. That is done by selling the put and buying the call option on the same strike. Now think about that strategy------------if the stock goes up, the call appreciates as it is in the money If the stock goes down, I will be put the stock at the strike and have lost the difference between the strike and where the stock is currently trading. Result: Nearly identical to owning the stock long. III)- The conclusion- The difference between the put premium sold and the call premium bought must reflect the cost of carry or time value explained in part I . And that is why call premiums are higher than put premiums when a stock is on a strike price with more than 30 minutes to expiration (I know someone will bring that up <gg>). If the put premium were higher than the call, you could put on the synthetic position at a discount to buying the stock outright as you would be in a net credit situation with no margin interrest owed. The pros would arb that by going long the synthetic and short the underlying locking in the spread. Hope that helps. I can show you other examples if need be. Regards Bob