I own 100 IBM shares (priced at $120) and I expect the IBM stock price to...

I own 100 IBM shares (priced at $120) and I expect the IBM stock price to decline by about 20% over the next 25 days. I decide to write one deep in-the-money call option contract with a maturity of 40 days against my IBM holdings. Is this an appropriate strategy for me, given my belief? Explain fully.

Expert Solution

Since you expects the price to fall, you believe that the price would be lower then current price.

Writing a call option means Selling a call option. i.e. You are bound to pay the buyer of the call option the difference in the Strike price and the future spot price if the stock price will rise.

Since you expect the price to be fall in 25days writing a call option is a smarter idea as because you enjoy the premium of the call option that you received from the buyer of the call.

It is worth to be noted that you expect price to fall in 25days but You decide to write a call option of 40 days which insreases the risk of extra 15days. If the price rise in these days it will create a loss in your pocket. Sugeestion is that the call should be of 25 days or very closer to it.

So the strategy is appropreiate on the side of writing a call option but again the call option is quite far from the expectaion. It must be approx 25days.

jeff jeffy answered 2 years ago

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