~The Mathematical Dynamics of Covered LEAP's~ Let me go through the math of an entire position set-up so it can give you guys more clarity...Let's use my Ford position since we've been referencing that one anyway...
When structuring these positions, you always want to have two key numbers in mind...
1) Your called return = (the return that you get if your position is called out)
2) Your unCalled Return = (the return that you get if your position is not called out)
So lets go through the math...
1) <Long side> = BUY ~F~ Jan 12.50 call @ $3.20
2) <Short Side> = SELL ~F~ June 15 call @ $0.57
In effect, we pay 3.20 and get a debit of 0.57
"Called Return"
"Un-Called Return"
Putting these numbers in perspective... So the way that we structured this position gives us the following risk/Reward ratio...
...Risk/Reward Ratio = -4.06%/+17.81%
Obviously, I thought that this particular Risk to Reward ratio was worth it because I established the position...
Understandably, some traders prefer different/better risk/reward ratios...Most of the time, you dont want to target a Risk/Reward that has a negative return...I only accepted this negative risk position because the un-called return is over 17%...{By the way, 17% a month isnt bad}...
Had I been a little more conservative, I could have achieved a position that had both a positive Called & Un-called return...Usually, if both returns are positive, then the trade off is less premium...For instance, I could have got a "Called Return" of +3-5%, but the trade off is that my un-called" return would have been 8% - 10%...(That is still a good profit for a months worth of time)... ...In this case, I just chose to accept a bit of risk for the exchange of a very nice premium...(17.81%)...Typically, you want to stick with both scenarios giving a positive return...
It's very important to do the math before you ever make the trade..."Plan the Trade...And Trade the Plan"...
I rarely hold the short side of the trade the entire time...It's best (in my opinion) to close the short side early (especially at a support level)...There are many things that you can do to manage positions depending on the situation...For instance, if ~F~ was trading at $15.09 on the last day of exp. , I may just buy back the position and re-establish another one further out in time...I usually do that if I really would like to keep the long side of the trade, and did not want to get called out...
Theres a lot of information to digest here, so last words of advice...Practice, Practice, Practice...You will master Covered LEAP's and even develop your own strategies...
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