EFTA01353454.pdf

EXAMPLE: When XYZ stock was $50. the inves- tor collected a S4 a share premium by writing an XYZ 50 delivery call. As expiration approaches, the stock has risen to $58 and he is assigned an exercise. His total return, in addition to any dividends received, will be the $50 exercise price he is paid for the stock plus the $4 premium collected when the option was writ- ten--$4 a share less than the $58 he could have sold the stock for if he had not written the option. On the other hand. if the value of the underlying interest declines substantially below the exercise price, the call is not likely to be exercised and. depend- ing upon the price paid for the underlying interest, the covered call writer could have an unrealized loss on the underlying interest. However, that loss will be wholly or partially offset by the premium he received when he wrote the option. 3. The writer of an uncovered call is in an extremely risky position and may incur large losses if the value of the underlying interest increases above the exercise price. The potential loss is unlimited for the writer of an uncovered call. When a physical delivery uncovered call is assigned an exercise, the writer will have to purchase the underlying interest in order to satisfy his obligation on the call, and his loss will be the excess of the purchase price over the exercise price of the call reduced by the premium received for writing the call. (In the case of a cash-settled option, the loss will be the cash settlement amount reduced by the premium.) Anything that may cause the price of the underlying interest to rise dramatically, such as a strong market rally or the announcement of a tender offer for an un- derlying stock at a price that is substantially above the prevailing market price, can cause large losses for an uncovered call writer. EXAMPLE: An investor receives a premium of $4 a share for writing an uncovered XYZ 50 call option and the stock price jumps to $69 as the option approaches expiration. If the investor liquidates his option position at, say, S19, in an offsetting closing purchase transac- tion, he will Incur a loss of $1,500 (the $1,900 paid in the offsetting purchase transaction less the $400 op- tion premium received when the option was written). The writer of an uncovered call is in an extremely risky position and may incur large losses. Moreover. as discussed in Chapter IX, a writer of uncovered calls must meet applicable margin requirements (which can rise substantially if the market moves adversely to the 63 CONFIDENTIAL - PURSUANT TOEFEESEIMCS0M824 P. 6(e) CONFIDENTIAL SDNY_GM_00184008 EFTA01353454