Buy-Write is an income producing option trade for situations with currently
high Implied Volatility.
option-info and options-graphs sites:
Outlook: Options currently have a very high IV relative to normal,
and you do not expect a dramatic drop in the stock price.
Buy stock, sell an ITM call with very high IV.
when: Stock does not fall below the current stock price - option
when: stock falls below the breakeven price.
Loss : Unlimited.
Calculation: Current stock price - option premium received.
compared to stock: Takes advantage of stock that does not move or
moves within a range.
compared to stock: Limited potential gains, possible large percentage
after entry, increasing implied volatility is negative.
after entry, the passage of time is positive.
Requirement : None (same strategy as a Covered Call).
Using an ATM strike will increase the potential gains, but also raise
the breakeven point.
Equivalent: Short Put using the same strike price.
- This is
a trade for special situations, in which the IV is currently at very
high levels, you expect the IV to return to normal, and you do not expect
a dramatic drop in the stock price. This may be the case when a stock
has had a sharp selloff that you do not expect to continue. The intent
is to take advantage of the high IV and receive a lot more premium than
normal, while still allowing for a good percentage move in the stock
either up or down.
- The trader
using this strategy normally expects to be called out of the stock,
since he sold a call below the current stock price. The gain is made
from the option premium, not stock movement. In the example trade, there
may be a good chance of a $191 gain on a $4309 investment in one month,
which is a 4.4% monthly gain, or about 53% annualized.
- The graph
for this strategy is the same as the Short
Put, OTM. You can use the Buy-Write version if you do not have permission
for naked options.
- The graph
of this strategy is the same as the graph of a Covered Call using the
same strike price. Normally a Covered Call would not use an ITM strike,
because you are practically guaranteeing you will be called out at a
very small gain if the IV is normal. You might want to read the Covered
Call strategy page and the Covered
Call Strategies Disadvantages page if you are considering this strategy.
this is a strategy with the potential for relatively small gains and
possibly large losses, you must control the losses. If the example stock
dropped to $44 or $45 at any time, the trade should probably be exited
for a relatively small loss. Trying to hang on could result in much
philosophy if the stock dropped below $45 would be to maintain the position,
hoping to realize the entire premium, in this case $691. That would
lower your "cost basis" in the stock to $43.09, and if the
IV is still high, you could write another ITM call for the next expiration
month. This is dangerous, since if the stock falls to $45 there is no
rule that says it can't drop much further, and you could lose much more
than $691 on a falling stock.
- If the
stock rises or holds steady, and the IV returns to normal, there will
be a good gain. The entire position should probably be closed if that
happens, to avoid the risk of the stock reversing.
- If the
stock stays near or above the entry price, the short calls will lose
value as time passes or if the IV drops back to normal. The entire position
can then be closed for a gain.
option if the trader is now more bullish on the stock is to close out
just the short calls for a gain on the options, while still holding
the stock for an expected bullish move.
- If the
trader adjusts to just long stock, he can now sell ITM, ATM, or OTM
calls against the stock with a later expiration date, depending on just
how bullish his opinion now is.