annualized yield.
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Table 3–3 Return If Exercised: Total Return, 27-Month OptionsName ofCompany
StockSymbol
StockPrice*
Exercise Price
OptionPremium
CloroxCompany
CLX
$55.91
60
5.10
9.1%
4.0%
Coca-Cola
KO
38.90
40
4.00
10.3
4.6
Yield
AnnualizedYield**
Exxon Mobil
XOM
48.70
50
4.50
9.2
4.1
Fannie Mae
FNM
67.65
70
8.30
12.3
5.5
FederalExpress
FDX
87.78
90
12.30
14.0
6.2
GeneralDynamics
GD
100.01
100
9.90
9.9
4.4
J.C. Penney
JCP
38.20
40
5.70
14.9
6.6
Pepsico(Pepsi-Cola)
PEP
48.48
50
4.30
8.9
4.0
WashingtonMutual
WM
38.43
40
3.10
8.1
3.6
Xerox
XRX
14.32
15
2.55
17.8
7.9
(1) Closing stock price at the time the position is opened, October 22, 2004.(2) To annualize returns, the holding period must be adjusted to reflect thereturn that would have been realized if the stock had been held for 1 year.Overall return [12 ÷ 27] = annualized yield.
Annualizing yield is important in the side-by-side analysis. We tend toallow ourselves to be deceived by the numbers without looking at thepercentages. For example, you may reject Xerox because the potential27-month premium is only 2.55 ($255) in comparison to the 12.30($1,230) you could earn on Federal Express over the same period.However, the annualized yield tells the real story. Return on Xerox is 7.9percent, compared to only 6.2 percent on Federal Express.Stock price can also be deceiving. You may compare the Xerox price of$14.32 per share to the Federal Express price of $87.78 and draw conclusions about the potential for returns based on those price differences. However, ownership of 600 shares of Xerox is approximatelyequivalent to ownership of 100 shares of Federal Express in terms ofcapital required. Even so, the annualized yield from writing coveredcalls is greater in the case of Xerox.
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OPTIONS TRADING FOR THE CONSERVATIVE INVESTOR
These calculations present outcomes for the stocks being studied on aconsistent basis. All comparisons involve 27-month LEAPS calls, soannualizing the returns reflects the comparative annual outcome. Tocontinue evaluating the portfolio-wide returns in these cases, you needto also track dividend income and growth in the stock’s market value.However, for option-specific returns, the results shown in Table 3–3are accurate.Using the alternative method of adding in dividends for the companies,we would change the outcomes on the basis shown in Table 3–4 (dividend information was obtained from each company’s Web site).Table 3–4 Alternative Method of Adding Dividends
Company
Dividend(Annual)
DividendYield
AnnualizedOption Yield
TotalYield
Clorox Company
$1.08
1.9%
4.0%
5.9%
Coca-Cola
1.00
2.6
4.6
7.2
Exxon Mobil
1.08
2.2
4.1
6.3
Fannie Mae
2.08
3.1
5.5
8.6
Federal Express
0.28
0.3
6.2
6.5
GeneralDynamics
1.44
1.4
4.4
5.8
J.C. Penney
0.50
1.3
6.6
7.9
Pepsico(Pepsi-Cola)
0.92
1.9
4.0
5.9
WashingtonMutual
1.80
4.7
3.6
8.3
Xerox
0.20
1.4
7.9
9.3
Dividend yield was calculated by dividing annual dividends paid, by theprice of stock at the time the option strategy was entered. While thisdoes not reflect the true dividend yield you would actually earn (thatwould depend on the price of stock at the time of purchase), this secondary analysis does provide valuable information. It shows how the
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annualized option return plus dividend yield would result in each case.Because the total yield using this method changes the total yield calculated in the previous method (making Xerox the most profitable stockbased on option premium and dividend yield), it may be more accurateto consider dividend yield as part of the return if exercised.We cannot ignore the fact that dividend yield affects the overall profitability and may also influence which stocks you would use for the covered call strategy. The most sensible approach perhaps is to makecalculations both with and without dividend yield, and then compareoutcomes.
Return If ExpiredComparing return if exercised, to return if expired, is useful to theextent that it shows the result of two possible outcomes. However, it isnot accurate to compare the two outcomes to decide which is preferable. From the conservative point of view, the covered call strategy issensible only if any of the possible outcomes would be justified; butconsider the problem of trying to compare exercise to expiration. Uponexercise, your stock is called away, and you then have a taxable capitalgain. In the case of expiration, you continue to own stock. You are freeto repeat the covered call strategy after expiration. This means youryield can recur repeatedly as long as exercise never happens, so a trueoverall comparison is not really possible. Given the potential for repetitive returns from the covered call strategy, the rate of turnoverbecomes important. The more often you can replace a current coveredcall with another, the higher your premium income. For this reason, ifthe stock is far enough out of the money so that the short call is worthvery little, closing it and writing a replacement call with more time untilexpiration could be more profitable than waiting out expiration on thecurrent call. Rather than setting a specific level for closing the position,the determining factor should rest with a combination of premiumvalue and time remaining. Thus, you must compare outcome scenarioswhen the attributes are so different. We want to use a basis for realisticcomparison, so the purpose in these calculations is to ensure that weknow the possible outcomes.
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OPTIONS TRADING FOR THE CONSERVATIVE INVESTOR
It is valid to compare the potential return to the stock’s current value.You must own the stock to enter the covered call strategy as a requirement under your conservative risk profile. Comparing yield to youroriginal cost makes it outdated, because there is no relationshipbetween today’s covered call strike price and your original purchaseprice. The validity of comparing expiration returns to today’s pricerests with the assumption that you would decide to select one or moreof these covered calls based on (a) proximity between strike price of thecall and today’s market price, (b) related premium levels, and (c) timeuntil expiration. The major difference between the two potential outcomes (exercise and expiration) is whether or not you continue to ownthe stock at the end of the strategy. This is where capital gains and dividend yield become important. The greater the distance between original cost and option strike price, the greater the capital gain; so incomparing return if exercised between two or more stocks, you mustconsider this as part of the comparison. The higher the annual dividendyield, the more value in keeping the stock; this also affects whether ornot to select a stock for covered call writing. You may select one stockover another primarily because combined premium and dividend yieldare higher than an alterative. You may also avoid using a particularstock for writing calls because of higher-than-average dividend yield(as in the case of Washington Mutual), based on your not wanting torisk high-yielding shares being called away. Referring again to overallreturn, you might decide to write calls on Xerox, with an overall 9.3percent return but very low dividend yield. In that way, you protectyour position in Washington Mutual, with its far higher dividend yield.Dividend yield has to be an important component in the selection ofstocks for covered call writing, whether you currently own the stock orare considering purchasing shares in the future. You may pursue highyielding stocks to increase returns, or you may avoid writing coveredcalls so that dividend yield can be preserved.It may be difficult to make completely reliable comparisons betweenreturn if exercised and return if expired. First, you may decide to close ashort option position well before expiration and write a replacement call,which increases the annualized return, substantially in some cases. If youdo hold the position until expiration, you can repeat the experienceindefinitely. In comparison, when the short call is exercised, your stock isChapter 3 Options in Context
75
called away; you can continue to write covered calls only by investingfunds in new shares of stock and waiting out market appreciation.Expiration may be the worst-case scenario if it yields the lower returncompared to closing or having stock called away. But you have control.You do not need to keep option positions open until expiration. By comparing if-expired returns to the alternative of closing positions today andreplacing them with richer premium short calls, consider the following:1. The net yield, on an annualized basis, of closing the call. That isthe difference between the original sales premium and the current closing purchase premium, net of transaction expenses,calculated on an annualized basis.2. The comparative yield on a new short call, given longer time toexpiration, higher time value premium, and proximity betweenstrike price and current market value.3. The increase, if any, in the strike price level. If the stock’s market value is higher today than when you sold the original call,consider selling calls with higher strike prices. This increasesyour capital gain in the event of exercise, yet keeps your position out of the money and maintains your conservative standard for covered call writing.With these variables in mind, worst case is difficult to quantify. Becausethe comparison is not entirely valid between stocks, it is not accurate toassign a preference of one outcome over another. All of the factors—including exercise, dividend yield, and capital gains—have to be considered as part of your analysis. The original cost of stock, proximitybetween cost and strike price, and proximity between current value andstrike price all affect your decision, and those factors may vary considerably between stocks.
Long-Term Goals as a Guiding ForceReturn comparisons, of course, are not the only forms of analysis needed to select an appropriate options strategy. Your long-term goals arethe guiding force that ultimately determines whether or not a strategy
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OPTIONS TRADING FOR THE CONSERVATIVE INVESTOR
makes sense. So, if you want to keep shares of stock and are willing togive up current returns from writing covered calls, that is a clear goal.In that situation, covered calls are inappropriate. However, if you seecovered call writing as a means for (a) taking paper profits without selling stock, (b) providing downside protection through reducing yourbasis in stock, and (c) enhancing current income beyond dividends,then a covered-call-writing program can help you manage your portfolio, exploit temporary market price changes, and overcome the worryabout paper profits and losses.Working within a conservative framework is not always an absolute oreasily defined criterion for how to invest or what products to select.Your level of conservatism changes with market circumstances. Thevarious options strategies enable you to take advantage of market highpoints without disposing of stock you prefer to keep. Degrees of conservatism are possible and may not be fixed. It may be considered conservative to use options at market extremes as long as large amounts ofcapital are not risked or exercise of short positions produces an undesirable outcome. That is an individual decision, and no universal standard can identify whether or not it is appropriate.Current circumstances affect how you invest, and they should. Asexplained in Chapter 7, it is not conservative to invest in the same manner in every situation. You need strategies for managing your portfoliosin down markets as well as in up markets; and options in their variousconfigurations are powerful tools for protecting your long-term positions and for identifying and taking profit opportunities without compromising your goals.There is a tendency to classify specific options strategies universally, sotaking long positions is always high-risk, and writing covered positionsis always safe. Neither of these statements is true, of course. For example, writing covered calls is ill-advised when the stock price isdepressed, especially if the current price of an underlying stock is lowerthan your basis. If you think prices are going to climb in the future toreverse the downtrend, then timing of the covered call write would bepoor. The best time is during high market volatility when the stock’sprice has run up and, in your opinion, is temporarily higher than itsnormal trading range. Not only will higher strike prices be available,
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but the implied volatility in the option could also make it a profitablecovered call opportunity.A more subtle variation of risk involves how you utilize cash. For example,when you receive option premium, where can you invest it? If you hope tocontinue earning a rate of return you think of as a minimum in your portfolio, you may feel compelled to invest cash receipts in some way.Dividends can be reinvested automatically if companies whose stock youown offer dividend reinvestment plans (DRIPs), in which partial shares ofstock can be acquired automatically in place of dividend cash payments.This makes sense because it creates a compound rate of return on dividend income. However, it is not as easy to create the same automatic compound returns when you sell options. Some choices include the following:1. Place funds received for selling options in well-selected mutualfunds. Select reinvestment of all income so that your moneycontinues earning compound rates.2. Group covered call sales to create enough funds to acquireshares in another company that you want to buy; or buy sharesand write calls at the same time, paying the net debit requiredfor both transactions. Make sure the company is on your list ofstocks that meet your fundamental requirements, rememberingto ensure that conservative risk rules apply. This action, combined with dividend reinvestment and the potential for additional option writing, puts premium income back to work asquickly as possible.3. Invest premium income in other investments, satisfy marginrequirements, or add funds to your personal cash reserve.Premium income can be used to augment a cash reserve as circumstances change, so you do not have to dispose of other assets;premium income can also serve as a source for the cash safety net.
Exercise as a Desirable OutcomeOne context of options that is often ignored is the desirability of exercisein some circumstances. Exercise is usually avoided as part of an overallstrategic approach based on your wanting to enhance current income
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OPTIONS TRADING FOR THE CONSERVATIVE INVESTOR
while doing all you can to keep well-selected, long-term growth stocks.In the covered call strategy, exercise is most likely when the stock’s priceis rising, so escaping exercise provides more capital gains in the stock, tobe realized later. Avoiding exercise by rolling out of positions is usually apractical method for managing covered call positions; even if exercisedoes occur in the future, it is preferable at a higher strike price. There arecircumstances in which you will welcome exercise:1. Writing deep in-the-money calls, even with tax consequences inmind. If you have a substantial carryover loss to bring forward,you are limited to a maximum of $3,000 per year in capitallosses you can claim. When your carryover is far above thatlevel, you will not be concerned about the loss of long-term status you suffer when writing deep in-the-money covered calls.In fact, in that situation, your covered-call-writing strategycould be designed to invite exercise. Since deep in-the-moneycalls consist mostly of intrinsic value, changes in the stock’smarket value are matched dollar for dollar by changes in thecall’s premium. Covered calls provide complete downside protection to the extent of intrinsic value in this case; for example,if your covered call contains 20 points of intrinsic value, youreceive the entire premium when you write the call; and theprice drops for each point loss in the stock or rises with eachpoint gained in the stock. The call can be closed for a purchaseprice below the original sale level if stock prices drop, so yourlost points in the stock can be recovered in the changed optionpremium. This strategy works only when two conditions arepresent: (1) you have substantial carryover loss and don’t careabout losing long-term treatment for covered call transactions,and (2) your basis in the stock is lower than the strike price orlower than the strike price minus call premium. (For example,if you bought stock at $35 per share and it is now worth $60,you may decide to sell a 30 call. That will bring you 30 pointsof intrinsic value plus whatever time value premium is available. It is entirely possible when stock has appreciated to thisextent to receive total call premium that exceeds your basis inthe stock. That makes any outcome risk-free; if you can takeout not only your basis, but extra profits as well, you have no
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net capital investment, but you still own long shares against ashort call. So, following such a transaction, a decline in thestock price could produce a profit in the call due to changes inintrinsic value.2. Selling puts as a form of contingent purchase when the strike pricemakes sense. If you are willing to buy stock at the short putstrike price, minus the premium, then exercise makes sense. Forexample, stock is currently valued at $33 per share and you canget 4 points for the 30 put. Upon exercise, you would acquireshares at the fixed strike price of $30 per share; your basiswould be $26 per share due to the $400 put premium you werepaid. The ideal condition is to experience exercise above $26,meaning your net basis would be lower than market value (notcounting trading fees).3. Accepting exercise when fundamental indicators have changed.You may find yourself in the interesting position of owningstock with a short covered call, to also discover that you nolonger want to own the stock. If the call is in the money, youcan simply accept exercise in this situation and take your profit.If tax consequences are not important to you (e.g., if you have alarge carryover loss), you could also roll down to a lower strikeprice, gain 5 points in additional profits, and accept the certainty of exercise. If you don’t want to wait for the outcome butprefer to exercise more quickly, you can roll down with thesame strike price; you can even execute an unusual rollback,replacing the original exercise price with one on an earlier date.Combined with a roll down, this creates net premium incomewhile accepting exercise as an exit strategy on shares of stock.The acceptance of exercise in this case may be more practicalthan closing a covered option position and perhaps taking aloss on the transaction just so that you would be free to sellshares of stock. As with the case of a deep in-the-money callwritten originally, this decision could affect the tax status ofyour stock; it is most practical when you want to absorb a largecarryover loss.
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OPTIONS TRADING FOR THE CONSERVATIVE INVESTOR
Inviting exercise is one method of dealing with ever-changing marketconditions. As a conservative investor, you continually struggle with theproblem of market volatility. Even when you believe stock is worthholding for the long term, how can you ensure that today’s paper profits are not lost in future market price movements? Several conservativestrategies can be used to accomplish these defensive goals. In Chapter 4,“Managing Profits and Losses,” we examine the intersting use of calls toprotect paper outfits.
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4MANAGING PROFITSAND LOSSESEveryone contends with short-term price fluctuations, and eventhe most conservative investor may be susceptible to profittaking. Options can be employed to protect profits and even totake those profits without selling stock. On the other side of theshort-term price question, options can be used effectively toeliminate loss positions through rescue strategies.
83
T
he conservative risk profile discourages short-term decisions,and speculation is contrary to your sensible investing philosophy.Your general buy-hold-sell rule is, buy well selected high-qualitystocks, hold for the long term, and sell only when the fundamentalschange. This smart investing approach does not preclude protectingprofits when price levels become volatile. You do not want to begin as aconservative and end up as a speculator. However, there are ways to takeprofits without selling stock and without increasing market risks. Insome instances, taking market risks makes sense, even though it is notgenerally a wise move to make.We begin by making distinctions between various investor profiles. As ageneral rule, a conservative investor is interested in preserving capitaland, as a result, wants to avoid risks. In stock market terms, risk usually refers to volatility (technical risk) or weak financial position (fundamental risk). A moderate investor is willing to assume somewhat greaterrisks as long as the potential for higher profits is present as well. A speculator or aggressive investor seeks the highest possible returns—oftenshort-term—and is willing to accept the highest levels of risk.These terms are by no means black and white, nor are they permanent.A particular profile is likely to change as financial and individual circumstances change. With investing experience, any profile is going toevolve based on the positive or negative outcomes of past decisions.Current market conditions also affect a particular risk profile directly.Self-defining labels rarely apply to anyone in every respect. In the following discussions, we assume that your profile is generally conservative, even though that will not always apply. Our discussions are basedon the assumption that, even while you may view yourself as conservative or moderate, you accept the premise that—under some circumstances—your risk profile is going to be more flexible than the labelmay imply.
84
The labels we use to define ourselves as investors are often challengedwhen we come to the question of when and how to take profits.Recalling that profit taking normally involves selling stock, it is contrary to your conservative profile to dispose of stock you would ratherkeep. But when you involve options, your choices expand significantly.Option strategies provide methods for protecting paper profits as theyexist today, making smart moves when market conditions change, andtaking profits without needing to sell stock.
Your Conservative DilemmaA conservative policy is intended to protect your investments from loss.By selecting long-term quality companies, you eliminate the volatilitythat threatens your portfolio’s value, and you set the goal of buildingequity over many years. Even so, you have to contend with ever-changingmarket conditions and the prospect of needing to modify your mix ofstocks. The most readily available information is short-term by nature,so you have to continually ensure that your portfolio-based buy-holdsell decisions are made using valid information.Short-term indicators can be very distracting. Momentary volatility inissues you own, especially when price spikes are part of marketwidevolatility, can be very distracting. Without gaining independent confirmation of apparent changes in trends, it is easy to make mistakes. Forexample, you may decide to sell stock to avoid further price declineswhen it is not necessary, or you may buy additional shares when pricessurge, only to realize later that a correction was virtually certain.Reacting to short-term indicators and trends is human nature, but itcan adversely affect the value of your conservative portfolio.The ongoing conflict between short-term market trends and your longterm mindset is efficiently managed with options. Used in the propercontext—for managing price volatility and not as a primary and speculative change in policy—options help smooth out the price volatilitythat characterizes the market while protecting profits. Ask yourselfthese questions:
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1. How often are paper profits one-time opportunities?2. With high-quality stocks, do you still consider long-termgrowth potential likely?3. Have you sold stocks prematurely, fearing the loss of profits?
Deciding How to Establish Your PoliciesMost investors can relate to all of these questions because they have afamiliar ring. If you have observed trends over time, you know that theprice gyrations occurring this week and this month have a short-termaspect and a long-term aspect. You are keenly aware of what occursfrom one day to the next, and you see daily reactions to political andbusiness news, to earnings reports, to rumors of interest rate hikes, andto an unending number of other reasons for prices to rise or fall. But inthe long-term context, short-term price changes and the daily reasonsfor daily price volatility really have nothing to do with long-term value.Conservative investing emphasizes fundamental corporate strength—competitive position, excellence of management, diversification,healthy capitalization, consistent dividend record, and so on—and isbased on faith in long-term fundamental indicators. With this in mind,it seems most logical to invest in high-quality stocks, monitor the fundamentals, and ignore short-term trends altogether.Even the most ardent fundamental investor may not want to take thisapproach exclusively. Profit taking is tempting. There is a way to takeprofits without selling stock. Some forms of trading can be made withlittle or no market risk. In Chapter 5, “Options as Cash Generators,” wedemonstrate how covered call writing using appreciated stock achievesthis end. The well-timed purchase of puts protects profits for only limited capital risk and also provides the choice of selling stock at a fixedprice (in the event of a rapid price decline) or closing the long put andtaking the profits.Selling stock when its price demonstrates short-term change may becontrary to your conservative strategy. However, rapid price movementmay also signal a change in the attributes of the company. If the fundamentals have changed and that manifests itself in the very price move-
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OPTIONS TRADING FOR THE CONSERVATIVE INVESTOR
ment you experience in the short term, the long-put strategy gives youa way out should you decide to exercise. So, using this strategy does notcontradict the conservative rule. In fact, the insurance aspect is conservative, and the contingency of providing a profitable exit strategy isboth conservative and prudent.
Managing Profits with OptionsThe very real problem of “managing” profits is often ignored byinvestors. (It may seem odd to refer to the “management” of profitsbecause the usual thinking is, you either sell to take profits or leavethem intact; but in fact, management is precisely what you want to do,even when your primary emphasis is on long-term growth.)The traditional advice to buy long-term stocks and ignore short-termvolatility is generally good advice. But ironically, it may also be irresponsible to simply leave it at that. Your on-going portfolio management involves many chores, mostly centered on monitoringfundamental indicators. If and when corporate strength, competitiveposition, dividend payments, earnings trends, capitalization, and otherfundamentals change, you may decide to sell shares and redirect a portion of your capital elsewhere. This is basic and sensible.
Basing Decisions on the FundamentalsConservative portfolio management is based on the fundamentals.Short-term price volatility—a technical indicator—can also be an earlywarning of emerging changes in the fundamentals. If volatility is asymptom of other problems—notably, of changes in fundamentalstrength—then watching prices carefully is a smart suggestion. It is notreliable, however; most market theories agree that short-term movement cannot be used as a predictive tool. When price volatility doesappear, it is worth checking. It may serve as a signal of some kind, soseeking confirmation in the fundamentals just makes sense.If price volatility is related to a serious decline in fundamental strength,it may help identify a change far earlier than do traditional methods.
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Price volatility does not consistently provide early signals; much of theshort-term volatility represents marketwide short-term trends, overreaction to news and events, or buying and selling trends among institutional investors that have little or nothing to do with the stock’slong-term growth potential. So, to the extent that you pay attention todaily or weekly price trends, it remains important to keep that indicator in context.The traditional advice given to conservative investors wanting to ensuresafety is to diversify their portfolios. While diversification is a basic andsensible idea, it does nothing to contend with short-term price volatility. Even with the best diversification, you still experience price surgesand declines; you still want to take profits or buy more stock atdepressed prices; and you must resist the temptation to react to shortterm trends for all the wrong reasons. Diversification protects youagainst specific risks, but it does nothing to ensure that you will nothave to live through price volatility.Yet another expansion of the diversified portfolio is to adopt a modelfor asset allocation. Under this variation, you “allocate” portions of yourcapital in different areas: stocks, mutual funds, real estate, cash reserves,precious metals, and so on. Asset allocation makes sense for the samereasons that diversification does, but it does not protect your portfoliofrom short-term volatility.Allocation may not be adequate to protect capital. Simply movingmoney around among different markets provides safety to your capital,but it does not protect you from all forms of market risk. The portionof your net worth that is invested in the stock market is subject toshort-term market risk, no matter how strong the long-term growth ofyour stocks. By the same argument, the short-term values in real estate,precious metals, and other allocated investments are vulnerable toshort-term market risk as well. The most conservative investor contends with market risk continually. Even those who stay out of the market cannot avoid loss altogether; the gradual loss of buying powerresulting from inflation, and the lost opportunity risk of being out ofall markets, combine to form a more serious problem than shortterm volatility.
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OPTIONS TRADING FOR THE CONSERVATIVE INVESTOR
The Reality of RiskYou cannot avoid all forms of risk. You can simply ignore short-termtrends and adopt the traditional conservative plan: monitor well-selectedstocks and sell only if and when the fundamentals change. Otherwise,ignore all short-term price volatility and wait out the market. Or youcan recognize the potential of short-term price volatility as a possiblesignal worth confirming through an examination of the fundamentals,and even take advantage of price movement, using options to limitexposure to additional risk, smooth out price volatility, and take profitswithout selling shares of stock.The two methods of protecting profits with options are buying putsand selling covered calls. Each of the attributes of these strategies isworth comparing. Table 4–1 summarizes the features of the long putand the short call.Table 4–1 Options to Protect Paper Profits: A Comparison
Buying Puts
Selling Calls
A form of insurance onlong stock holdings.
Contingent sale in the event ofexercise.
Stock price decline is offsetby increased put premiumvalue.
Stock price decline is offset byreduced call premium value.
Price offset is unlimited aslong as the put exists.
Price offset is limited to premiumreceived in sale of call.
You pay to acquire the put.
You are paid for selling the call.
Time value declines mayoffset your in-the-moneygains.
Time value decline is profitable inthe short position.
The decision to use long puts or short calls rests with your long-termopinions about long or short positions. If you view long puts as strictlyworking to provide insurance, it is conservative to protect profits without risking stock positions. In comparison, covered call writing presents
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the possibility of exercise in exchange for money flowing in rather thanout and for providing a reduction in your basis, thus programmed higher profits in the event of exercise. This downside protection makes shortcalls more attractive in most respects. But picking one or the other is amatter of preference and, to some extent, it depends on what you originally paid for stock. If your basis is vastly appreciated, you may be happyin the event of exercise, so the short call makes sense. However, if youview covered calls as inappropriate because you do not want to haveshares called away, then the long put may be the