Chapter 3 - Basic option strategies: Covered calls and protective puts. This chapter presents the following content: Using options as a hedge, using options to generate income, profit and loss diagrams with seasoned stock positions, improving on the market. | © 2004 South-Western Publishing Chapter 3 Basic Option Strategies: Covered Calls and Protective Puts Outline Using options as a hedge Using options to generate income Profit and loss diagrams with seasoned stock positions Improving on the market Using Options as A Hedge Introduction Protective puts Using calls to hedge a short position Writing covered calls to protect against market downturns Introduction Hedgers transfer unwanted risk to speculators who are willing to bear it ., insuring a home Insurance that expires without a claim does not constitute a waste of money Protective Puts Definition Microsoft example Logic behind the protective put Synthetic options Definition A protective put is a descriptive term given to a long stock position combined with a long put position Investors may anticipate a decline in the value of an investment but cannot conveniently sell Microsoft Example Assume you purchased Microsoft for $ Stock price at option expiration Profit or loss ($) 0 Microsoft Example (cont’d) Assume you purchased a Microsoft APR 25 put for $ Stock price at option expiration 0 25 Microsoft Example (cont’d) Construct a profit and loss worksheet to form the protective put: Stock Price at Option Expiration 0 5 15 25 30 40 Long stock @ $ Long $25 put @ $ Net Microsoft Example (cont’d) The worksheet shows that The maximum loss is $ The maximum loss occurs at all stock prices of $25 or below The put breaks even somewhere between $25 and $30 (it is exactly $) The maximum gain is unlimited Microsoft Example (cont’d) Protective put Stock price at option expiration 0 25 Logic Behind the Protective Put A protective put is like an insurance policy You can choose how much protection you want The put premium is what you pay to make large losses | © 2004 South-Western Publishing Chapter 3 Basic Option Strategies: Covered Calls and Protective Puts Outline Using options as a hedge Using options to generate income Profit and loss diagrams with seasoned stock positions Improving on the market Using Options as A Hedge Introduction Protective puts Using calls to hedge a short position Writing covered calls to protect against market downturns Introduction Hedgers transfer unwanted risk to speculators who are willing to bear it ., insuring a home Insurance that expires without a claim does not constitute a waste of money Protective Puts Definition Microsoft example Logic behind the protective put Synthetic options Definition A protective put is a descriptive term given to a long stock position combined with a long put position Investors may anticipate a decline in the value of an investment but cannot conveniently sell Microsoft Example Assume you purchased Microsoft for $ Stock price at option .
