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Rescue Strategies

If you write a short combination or a short straddle, it is conservative as long as you own 100 shares for each call written. This assumes that the fundamental value of the stock has been established and that you would welcome exercise. In the preceding example, we established that a straddle on Fannie Mae produced an annualized yield of 18.2 percent and discounted the cost of stock to $52.25 per share. However, if the put were exercised, the true net cost of 200 shares (original 100 plus additional 100 shares put to you) would end up at $61.13 per share.

If the stock's market value were to fall below $61.13 per share, you would have a net loss. Remember, if your assumed fair price level for the stock is accurate, the decline may be viewed as short-term—as long as the fundamental strength of the company does not change. The price will most likely rebound above $61.13 per share at some point in the future.


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