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Non-Tech : Bill Wexler's Dog Pound -- Ignore unavailable to you. Want to Upgrade?

To: Cautious_Optimist who wrote (876)	4/28/1999 8:54:00 PM
From: Daniel Chisholm	Respond to of 10293

If you write a naked call, you take in premium (which is your maximum possible profit), and you bear the risk of the stock going out over the strike price. The risk of loss to a naked call writer and a short seller are similar - the higher the stock goes, the greater the loss, with no theoretical limit. The potential profit is a bit different though. A short seller can theoretically realize 100% of the price he shorted the stock at. The maximum theoretical profit available to a short seller (i.e., 100% of the short sale price, in the case that the stock goes to zero) is always greater than the maximum theoretical profit available to a naked call writer (100% of the premium received, in the case that the stock ends up at or below the strike price at expiration). However, to compensate the call option writer for the smaller potential profit even though he bears the same risk of ultimate doom as a short seller, the premium he receives raises his break-even point to be the strike price + premium received. This gives him a "head start" in profitability over the short seller, in order to compensate him for the reduced profit potential. In other words, shorting a stock is not exactly the same as writing a naked call, although it has certain similarities (you have a large potential loss; you benefit from a falling stock price). In order to make a short position "identical" to a naked call, one must also sell (write) a put option (at the same strike price as the naked call option you wish to be equivalent to). Writing a put position means that you are surrendering much of the profit potential of your short position, but in return you receive a premium, which raises your break-even price. When you do the math, and consider the various possible arbitrage opportunities (which other market participants will do even if you don't), options end up being priced (usually! ;-) such that a covered put position (short stock plus write a put) ends up being equivalent to a naked call position. Clear as mud? I thought so.... :-( - Daniel

To: Cautious_Optimist who wrote (876)	4/29/1999 10:19:00 AM
From: Marconi	Respond to of 10293

Hello Mr. Einstoss: [somewhat OT--options vs. stocks] Options and stock price are coupled through stock price. Options are priced largely on the volatility of stock price (time premium and volatility premium). Shares are priced largely on expected earnings and the day to day meanderings from the general market expectations reflected in stock price. Options are contracts that expire on a definite day at a definite (strike) price. They are always a wasting asset. Shorting junk stocks is counting on the economic wastage of the firms assets by bad management practices over time. Another analogy would be options are like variance in a distribution in statistics, and stock price is like an average (of expectations). Mean and variance in normalized classical statistics are unrelated. Through price level options and stock price are related in the market, but the underlying value of the two securities is derives fundamentally differently, with options priced according to variability and the stock priced along the lines of expected expected earnings. Stock price gets interesting on SI when you have two very diametrically polarized factions--fanatical longs with fantastical thinking and generally the more considered shorts, although they are known for their passionateness at times, too. I find seasoned short sellers rank as top drawer in diligence; this contrasts with the general sense of lunacy in the impassioned longs , "this baby is going to the moon....." And I believe this dichotomy is reflected in the market experience--stocks that are heavily shorted tend to go down more than average in the long run. And it can be a long run before they go down. Together, options and their underlying stock, can be used to adjust the variability in expected return from fully hedged for a cowardly return to nakedly exposed through options alone for maximum variation in returns. Practically the downside has to be survived when taking maximumly leveraged positions through naked options alone. In statistics, I was taught how you can always win and win big at say the roulette wheel in gambling. Double your bet every time you lose until you win. It works. The major caveat is you may run out of capital before you hit the win. Same deal in managing a high volatility portfolio. Avoid taking positions that risk being wiped out. BTW. I do not gamble on general principle. I will earn my daily bread, not take it in a game of chance from my fellow man. As for fun gambling, I can avoid that pleasure and avoid taking on the appearance of sanctioning gambling. Gamblers in stocks and options are far more likely to be wiped out in the long than investors who are taking positions in securities that are mispriced. Gamblers are after the thrill. It is okay to be thrilled at a tidy return on an investment. To be after the thrill only is to already have violated one of the necessary boundaries for investing prudently. Time will ultimately winnow the gambler from their wherewithal to participate in the market. I hope this helps on perspectives. There are many excellent summaries of investments. Sharpe's book was a classic for me decades ago. Best regards m