Question

Disadvantages of applying cover call and strip trade in speculator. (250 words)

Answer 1

Cover Call: Covered call is the transaction in the financial market in which the seller sells the right of shares purchased already to someone at a specific price and within a specified time period. For this he holds the stock for certain period and sells it in the financial market at a period when he will be able to get the profit. Thus he uses the stock to gain an income stream.

Disadvantages of Cover call:

1) If the stock rises above the stock price, the seller does not enjoy the full benefit. His profit is limited to the premium plus the difference between the options strike price and the stocks purchase price.

2) Premiums will be based on the historical volatility of the underlying stock. There will be great risk of price fluctuations for the stocks which have high premiums.

3) The seller of the option cannot sell the stock before buying back its call option

4) There will be a loss if the price of the option falls down greater than the premium.

5) Losses due to the downward moves are limited to the premium amount received.

Strip Trade:

STRIPS refers to Separate Trading of Registered Interests and Principal of Securities.. Strip is coupon bond which is separated as interest and principal from the bond to trade it separately.

Disadvantages:

1) It is very expensive

2) There will be negative influence on the position if there is a wide spread of bid

3) In order to generate the profit, the share price should change significantly.