An Easier Way To Trade Buy-Writes
WHAT IS A BUY-WRITE?
The term buy-write is completely foreign to most retail investors. Infact, more than a few professional traders scratch their heads wheneverthey hear this strange piece of options jargon.
If you look up the term buy-write in a modern options glossary or educational program, chancesare that you wonít find it. Thatís because the term itself is athrowback to the dawn of the options markets. Those were the good olddays when options were considered new products and options traders usedan entirely different set of jargon than they use today.
However, when you actually examine the term buy-write, its meaningquickly becomes clear. A buy-write is simply a strategy that involves purchasing the underlying and writing (a.k.a. selling), acall against it.
This strategy probably sounds familiar to you. Most options users today refer to this as a covered call andit is one of the most popular options strategies ever devised.
NO TIME TO ROLL CALLS
Aside from the archaic name, why should you be interested inbuy-writes? I wonít go into the numerous benefits of selling callsagainst equity positions in this article. (You can read more about covered calls in "Managing A Covered Call Portfolio" and "Basic Options Strategies: Covered Calls.")
However, despite these benefits, there has always been asignificant downside associated with selling covered calls. Thisdownside has prevented buy-writes from being adopted by significantsegments of the retail and institutional market.
The problem is that executing a buy-write strategy, particularly on alarge portfolio, is a complex and time-intensive prospect. First, youhave to determine which calls to sell against your portfolio. Then youhave to calculate the exact number of calls that you need to sell toobtain your desired rate of return.
Finally, if your strategy doesnít pay off in the time allotted, or ifyou would like to continue your strategy for a longer time period, thenyouíll need to roll your calls forward and repeat the entire processagain.
Each of these steps can be extremely cumbersome, especially foran options newcomer. Busy retail customers, fund managers and financialadvisers simply don't have time to go through these steps everymonth or two.
STREAMLINING THE PROCESS
A great deal of effort has been expended in recent years to overcomethis hurdle. After all, if the process of calculating and writing callsagainst equity positions could be automated, or at least streamlined,then it would go a long way toward expanding the adoption of thisstrategy among busy professionals.
The ultimate goal of this effort is to create a single product thatreplicates the returns of a covered call strategy but eliminates all ofthe grunt work. Unfortunately, the large number of variables involvedin the buy-write process make it extremely difficult to replicate.
INCOME VS. CAPITAL APPRECIATION
For example, how do you balance the desire for capital appreciationwith the need to generate income? If you choose to incorporateat-the-money calls into your buy-write strategy, then you will generatesignificant amounts of income but also eliminate any possibility forcapital appreciation.
Alternately, you could attempt to maximize your potential for capitalappreciation by selling far out-of-the-money calls. However, the paltryamount of income generated from these calls would make thestrategy essentially worthless.
Experienced sellers of covered calls usually opt for a middle groundthat provides income but also allows for a modest amount of capitalappreciation. Unfortunately, an automated technique that allowscustomers to find that elusive middle ground has yet to materialize.
To Be Continued...
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