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Long or Short Positions

The obvious problem with advanced strategies is the high-risk attributes of each. Positions involving long calls and puts require substantial point movement; even in a net debit position (in which the cost exceeds the receipt), you must fight against time value. Positions with any short calls or puts involve questions of market risk. Uncovered calls are the highest risk position possible using options—clearly inappropriate in a conservative portfolio. Short puts may or may not be appropriate either, depending on your opinion of the underlying stock, its fundamental strength, and whether or not you are willing to buy shares at the put's strike price.

When the mix between long and short positions is used, the possible variations of spreads and straddles present conservative possibilities. Some have already been introduced. For example, to remove the risk factor from a ratio write, you can add a long call at the top of the strategy. If you own 300 shares, you might write four calls with a strike of 50. You also buy a call at 55, 5 points above the strike price of the ratio. thus covering the uncovered short option. The net receipts from the short calls come to $2,200, and the long call costs $100, so your net cost before trading expenses is $2,100. The top-side long position is a form of market risk insurance; if the stock's price were to rise so that all four calls were exercised, you could cover three of them with your 300 shares; the remaining call is covered with your long 55 call. You would lose $500 on the difference between those strike prices. However, there are two mitigating factors. First, you received $2,100 for the overall ratio write. Second, the $500 loss is preferable to the possibility of being exercised and losing much more. This is a conservative use of options to manage a ratio write, transferring it from a potentially risky strategy to a very safe one.


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