EFTA01393130.pdf

writer's position). Uncovered call option writing is thus suitable only for the knowledgeable investor who un- derstands the risks, has the financial capacity and will- ingness to incur potentially substantial losses, and has sufficient liquid assets to meet applicable margin requirements. 4. As with writing uncovered calls. the risk of writing put options is substantial. The writer of a put option bears a risk of loss if the value of the underlying interest declines below the exercise price, and such loss could be substantial if the decline is significant. The writer of a put bears the risk of a decline in the price of the underlying interest—potentially to zero. A put writer of a physical delivery option who is assigned an exercise must purchase the underlying interest at the exercise price—which could be substantially greater than the current market price of the underlying interest—and a put writer of a cash-settled option must pay a cash settlement amount which reflects the decline in the value of the underlying interest below the exercise price. Unless the put is a cash-secured put (discussed below), its writer is required to maintain margin with his brokerage firm. Moreover, the writer's purchase of the underlying interest upon being assigned an exercise of a physical delivery option may result in an additional margin call. A requisite for writing puts is an understanding of the risks. the financial capacity and willingness to incur potentially substantial losses, and the liquidity to meet margin requirements and to buy the underlying inter- est. or to pay the cash settlement amount, in the event the option is exercised. A writer of an American-style put can be assigned an exercise at any time during the life of the option until such time as he enters into a closing transaction with respect to the option. Since exercise will ordinarily occur only if the market price of the underlying interest is below the exercise price of the option, the put writer of a physical delivery option can expect to pay more for the underlying interest upon exercise than its then market value. EXAMPLE: At a time when XYZ stock is 550, an investor receives a $300 premium ($3 a share) by writ- ing an XYZ 50 put. Subsequently the stock price de- clines to $40 and he is assigned an exercise. The investor must purchase the stock at 850. Even though the $3 a share premium reduces his effective cost to $47, that is still substantially higher than the $40 mar- ket price of the stock. 64 CONFIDENTIAL - PURSUANT TOEFEESERMI$066549 P. 6(e) CONFIDENTIAL SDNY_GM_00244733 EFTA01393130