Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 323

(who is safety-minded) to hold onto the underlying shares until the expiration date with the risk that the shares may get assigned at that time. Again if Ford is trading at $50 in early January 2000 and you have 200 Ford shares, you can sell two covered WFOAJ contracts with an $11 premium against those 200 shares for a total of $2,200. The catch is that your 200 shares will be locked up until January 2002 when those contracts expire unless you settle those contracts earlier. If at expiration Ford happens to be at $50 or below, those contracts expire worthless, you keep the proceeds from the sale of the covered call LEAPS, and you continue to hold on to your shares or maybe even sell another two covered call LEAPS contracts for 2004. If on the other hand Ford is trading at $90 come expiration, you would have to surrender those 200 shares at $50 per share. Sure it would have been better not to have written those covered calls and just to sell those 200 shares at a $40 per share profit, but that's the small risk your accepted. At least you collected the $11 premium per share, which is yours to keep no matter what.

Splits

A question that comes to mind is what happens to those options whose underlying stocks split, reverse split, get acquired by another company, or go private (perhaps through LBO)? Surely it would be unfair for those holding FAJ January 50 calls if Ford splits 2 for 1. Those options, as they are, would certainly expire worthless. Well, don't worry about it too much. Options, per OCC rules, are either split the same way or adjusted to closely match the events of the underlying stock. In the FAJ case, if Ford does indeed split 2 for 1, the FAJ holders would end up with two contracts with the strike price of $25 (with the symbol FAE) for each FAJ contract. The expiration date would remain the same.


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