Closing Out a Contract for Partial Recovery




Provided By optiontradingstrategies.org

The preceding example of a Call contract for speculation showed a handsome profit. Suppose that when a Call option at 50 was about to expire the stock was selling at 52.

A While the holder of the Call contract could not recover all of his premium of $350, he could, nevertheless, Call for his stock at 50 and sell it in the market at 52, so instead of losing the $350 premium, he would recover $200 of it.

His account would read:
Bought Call XYZ at 50-cost $ 350
Bought 100 shares a/c Call 5,000
$5,350
Sold 100 shares in market 52 $5,200
Loss $ 150

(For simplification Stock Exchange commissions have been omitted.)

Selling Stock and Buying a Call to Maintain a Position

A man is "long" 100 shares of XYZ now selling at 50. The stock is owned outright or is held on margin, but the man needs the money in his business. However, he does not like to lose his stock position. He might consider the following: He sells his stock at 50, releasing his funds, and at the same time buys a Call option at 50 good for 90 days at a cost of $350.00. If the stock advances, he exercises his Call and thereby re-acquires his stock. He may then sell the stock that he acquired through the Call and take his profit, or he may care to carry the stock at 50 which is now selling in the market at 60. If, on the other hand, the stock declines to 40, he lets the Call option expire and now he can, if it suits him, re-acquire at 40 the stock that he sold in the market at 50. Through the Call contract, he accomplished two things—he released the $5,000 that he had invested and also had control over the same number of shares for the duration of his option, and at the same price that he sold them.

The Use of a Call Contract for Trading Purposes

If one is an astute trader and the market offers the opportunities, Call options can be used quite profitably and at all times with a limited risk.

Suppose a trader bought a 90-day Call option at the current market price of 50, for which he paid $350, and that the contract was to expire on December 31. Let us also suppose that some time in October the stock rose to 55, at which point the trader sold short 100 shares. This short-sale—and it must be sold as "short" stock—must be margined with his stock-exchange broker, but at this point the trade is risk less. The trader has a 5-point profit less the cost of the Call at any time that he cares to exercise his option. But he doesn't care to exercise his option because it has about 2 months to run and the fluctuations in the market price of the stock in that 2-month period may give him additional opportunities to trade. Let us say that after having made the short-sale at 55, the market declines in another week or so to 50, where Mr. Trader sees fit to buy in or cover his short-sale. His account now looks like this:

Sold 100 shares at 55 $5,500
Bought 100 shares at 50 $5,000
Cost of Call Option 350
Total Cost.... $5,350
Profit $ 150

But the Call runs until December 31, and the trade which was made does not nullify the option. In another week or so, because of some news, the stock rallies to 56, where Mr. Trader again sees fit to sell short. Again he has a riskless, profitable transaction, and in a week or so the stock again declines to 50, at which point the short-sale is covered. On this trade another profit of $600 is added to the $150 already made.

Sold 100 shares at 56 $5,600
Bought 100 shares at 50 5,000
Profit $ 600

Past performances of many stocks show that such opportunities are far from rare and there have been instances of as many as twelve full trades made against a Call before its expiration. Without owning the Call, Mr. Trader might have been fearful of making a short-sale but, knowing that he could always cover the short-sale at 50 through the terms of his Call contract, he does not hesitate to trade. Suppose, for argument's sake, that after having made the short-sale at 56, the stock advances to 70 and stays at about that price. The trader merely exercises his call, thereby covering at 50, through the terms of his contract, the short-sale that he made at 56. Without the Call option he would have a 14-point loss, and even though the short-sale would prove to be a bad trade, his guaranteed trade would show a profit. Just as a Call can be used to protect a trade for trading purpose, Call options can also be used to:

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