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Strategies & Market Trends : Options for Newbies -(Help Me Obi-Wan-Kenobe) -- Ignore unavailable to you. Want to Upgrade?

To: PoetTrader who wrote (2119)	6/20/2001 11:14:17 PM
From: Dan Duchardt	Read Replies (2) \| Respond to of 2241

PoetTrader, But what if you wanted to gamble a little and wrote Aug45's...yes, it's below your "in" price, but there's probably also a good chance that Cien won't hit 45 anytime soon, and with time decay you could buy it up and close it out two weeks into August...and then continue to do that until cien comes back? Aren't you just making more money and reducing your cost basis? If it is a stock you plan to hold for YEARS, then isn't this strategy okay? Yes, you certainly can take this "gamble" that you will be able to gradually reduce your net investment and eventually come out ahead. The problem can be maintaining the discipline and frame of mind to accept the possibility that the stock will bounce as hard as it fell and take you out at a loss as you watch the stock run to greater heights. After you live through that a few times, it's easy to get caught up in the coulda woulda shoulda syndrome. "If only I had waited for the stock to go up before writing those calls" OR "If only I had written those calls before this thing fell another 20%.. 30%" whatever. The question you really need to ask going into a position like this is whether the time premium you collect by writing calls is worth the potential consequences. For a stock like CIEN, that has a history of moving 20% to 40% within 5 to 10 trading days, is it really worth it to be selling calls to collect a 5% premium, or much less than that if you throw a protective put into the mix?. It's hard to make a case for being on the CC writer's side in that situation unless you are willing to unwind the position and take a small loss early. On a stock that can move this fast, option buyers are in a safer position. Suppose you could start over and thinking to yourself that CIEN at $61.50 had a real good chance of going well over $70 you wanted to limit your risk, but still enjoy the potential reward. On June 7 you could have bought a JUL60 call for about $7. That is pretty expensive considering the stock had to go to $67 before you started to make any profit, but the worst thing that could possibly happen is that you lose $7. Had CIEN gone to $80 you would have made just as much as the CC would have made, but with an initial investment and risk of only $7 instead of $58, and had it gone even higher you would have had unlimited upside potential. This is not meant to convince you that buying ATM calls is all that wonderful either, because it's real easy to lose your entire investment, but if you limit the number of calls to controlling the same number of shares you could have purchased, and kept the $51 you did not the use in a very safe place, it would actually be less risky than writing the CC. One way to improve the safety of writing CCs is to go farther out to give the stock time to recover from a nasty drop, and to collect more premium up front. This of course diminishes the potential rate of return, but it does improve the downside protection and gives better opportunity for rolling down the strike price as a stock falls to reduce the losses. Writing calls that are ATM instead of OTM generates greater time premium, so further improves the downside protection. Some people advocate writing ITM calls when the market looks weak, but I do not agree with that because unless you are collecting a healthy TIME premium you are far better off simply buying less stock instead buying more shares and selling ITM calls. It would be a good exercise for you to compare the potential risk and reward of owning half as much stock, with no written calls, to the CC position. What you will find is that for small stock movement the CC is best, but for any large move either up or down you are better off simply owning the half position. In this case, the range where the CC was better was skewed to the up side (because of writing OTM calls), all the way up to about $82, but for anything below about $55 the half position would suffer less loss. Above $82 the half position would make a greater gain (in dollars!!, not just per cent). If you think a stock has high potential of moving outside of the CC preference range, you are better off with another strategy. Dan