Why Investors Use the Buy-Write Trading Strategy
Seasoned investors and stock traders have various strategies to deal with various trading scenarios. One such strategy is the buy-write method. TradeZero Ocean Place Cable Beach, Unit #1 Nassau, Bahamas
As you progress in stock trading there are various scenarios you’ll face, and you need to keep educating yourself as to the strategies you can employ. Trading education continues, and one such strategy you may see investors using is the buy-write strategy. Analyzing the Buy-Write Strategy In-depth Investopedia explains that buy-write refers to an options trading strategy by which investors buy an asset such as a stock and sell/write a call option on it simultaneously with the aim of generating income from option premiums. The risks involved in writing the option are reduced because of the options premium being covered by position underlying. This strategy is similar to a covered call on a position existing in the underlying asset, with the primary difference being the timing in which both the trades are done. The Working of the Buy-Write Strategy The buy-write strategy takes the assumption that the underlying asset’s market price will not significantly rise from the present levels before expiration. Then the investor who writes the call
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option will be able to keep the premium from the sale of the option. The option’s strike price must be higher than the underlying asset’s price. However, the higher the strike the farther it gets out of the money. So the premium received is lesser. And the longer it takes until expiration, the higher you can expect the premium to be. If the expiration is farther, there is a greater likelihood of the market losing liquidity which causes inefficient pricing. So balancing between the strike price and the expiration is essential for investors. If the underlying asset price rises higher than the strike price, the option is either exercised at maturity or before. This causes the investor to sell the asset at the price of the strike. The investor gets to keep the premium received without, however, benefiting from the further gain in the price of the underlying asset. The investor caps the gain on the underlying asset as exchange for the income from the premium. The investor hopes the underlying asset will not experience a short-term rally but a long-term one. And in the waiting period for the long-term price rise, the investor is able to earn income on the asset.
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An Example to Figure out the Strategy For instance, if an investor thinks a particular stock makes for great long-term investment but isn’t quite sure when the product it manufactures will end up becoming profitable, he buys a 100share position in that stock at its $10-per-share market price. Since the investor does not think a price rally will happen soon, he writes a call option for the stock at a $12.50 exercise price, managing to sell the stock for a premium though small. If the stock remains below $12.50 till maturity, the trader will enjoy the underlying stock as well as the premium. If the stock price increases beyond $12.50 and gets exercised, the investor needs to sell the shares to the option holder at $12.50. The trader only loses out on the exercise price and market price difference. If the market price is $13 per share at expiration, the trader doesn’t receive the additional profit of $0.50 per share ($13.00 - $12.50). This isn’t money lost, though. If the investor writes a naked or uncovered call, he would need to get to the open market for buying shares to deliver. The $0.50 per share would end up becoming a capital loss.
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Hope this bit of trading education has cleared the mystery behind some of the trading strategies used by seasoned investors. To start successful stock trading, you need a great online trading platform with free stock trading offered. It then takes off from there.
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+1.954.944.3885