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Technology Stocks : Dell Technologies Inc. -- Ignore unavailable to you. Want to Upgrade?

To: Geoff Nunn who wrote (72752)	10/17/1998 1:35:00 PM
From: Chuzzlewit	Read Replies (2) \| Respond to of 176387

Geoff, re: covered calls Well, let me respond to your quibble with my quibble. You observed that: The market is saying, is it not, that in return for the high premiums you would earn on the calls, you will bear a high risk that the stock will plunge. If you are simply saying that the more volatile the stock, the higher the premium it commands, then I agree. That is one of the fundamental parameters determining the price of an option. But if you are suggesting that there is increased risk to the holder of a covered call in a declining market then I think you are looking at this backwards. If the stock plunges your risk is reduced if you hold the call to expiry. If you decide to exit the position before expiry you will also have reduced your risk because the calls should have decreased in value to reflect not only thr reduced price of the stock, but the decrease in value due to the erosion of the time premium. Let me illustrate with a pure hypothetical (warning: I am making all of the following numbers up). Suppose XYZ is selling at $45 and the one month $50 call option is selling for $2. Now suppose you establish a covered call position so your net position is $43. Now lets assume the price decreases to $40 and you decide to exit the position in fifteen days. It is entirely likely that you could repurchase the call for about $.50 so you would have a net cash position of $39.50. On a percent basis your loss would be 8.14%. But had you simply owned the stock and sold, your loss would have been 11.1%. In fact, for your loss to be equal to that of the underlying stock you would need to loose $4.78. That would require the option to be priced at $1.78 at the time you repurchased it. The conclusion must be that writing call options decreases the risk of stock ownership. Now, as to you second point: the length of the option. If you look at the decrease in the time value of the option I think you will generally find that it is the greatest during the final month of its life. I write covered calls in my IRA, so taxes are not a consideration, but even if they were the time value of the tax deferral does not make up for the decreased time value per day for the option. Let me illustrate with some actual numbers as I recall them. With about 3 weeks to run, Dell 65's were going for around $3.50. The option with the same strike price but 1 month additional time before expiry was selling at around $6.00. So you could look at it this way: you receive $3.50/21 or roughly $.17/day for the first optioned period, but only ($6.00- $3.50)/30 or $.08/day for the second period. TTFN, CTC