Monday, May 12, 2008

Vol #3 Strategy with Calculation on returns....

Today let's do some simple calculation on our expected returns
If you establish a buy/write on Microsoft (MSFT) trading at $54.05

February 55 call (3 weeks): $1.35-$1.45
February 60 call (3 weeks): $0.15-$0.25
February 65 call (3 weeks): $0.00-$0.10
March 55 call (7 weeks): $2.45-$2.55
March 60 call (7 weeks): $0.75-$0.80
March 65 call (7 weeks): $0.20-$0.25

Let say investor choose March 65 calls:
With the purchase of 400 shares MSFT and writes 4 March 55 calls @ $2.45.
We need to calculate for every possibilities:

1. Static Return
What if the underlying stock remains unchanged for the 7 weeks.
The return will be $2.45 / ($54.05-$2.45) = 4.75%
You'll need to annualized this for comparing buy /writes using options with varying terms to expirations. (Some 3 weeks, some 7 weeks) (4.75% x 52 weeks) / 7 weeks = 35.3%

2. If-Called Return
Best case scenario: If the option is called. This require the underlying stock to raise the above targeted price.
Maximum return the strategy can generate: ($2.45 + $0.95) / ($54.05 - $2.45) = 6.59%
Annualized it: (6.59% x 52 weeks) / 7 weeks = 49%

Now we have our two scenarios:
If the stock stay relatively unchanged (below the strike price) vs bull market (over the strike price)

Returns 4.75% vs 6.59%
Annualized 35.3% vs 49%

Of course, the annualized rate of returns only applicable if and only if you can get the same returns 6.59% over every 7 weeks in that whole year. :)

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