36 lines
2.8 KiB
Plaintext
36 lines
2.8 KiB
Plaintext
482 Part IV: Additional Considerations
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follow-up monitoring technique, using the deltas of the options involved, is present
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ed later in this chapter, and has been described several times previously.
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FACILITATION OR INSTITUTIONAL BLOCK POSITIONING
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In this and the following section, the advantages of using the hedge ratio are outlined.
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These strategies are primarily member firm, not public customer, strategies, since
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they are best applied in the absence of commission costs. An institutional block trad
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er may be able to use options to help him in his positioning, particularly when he is
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trying to help a client in a stock transaction.
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Suppose that a block trader wants to make a bid for stock to facilitate a cus
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tomer's sell order. If he wants some sort of a hedge until he can sell the stock that he
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buys, and the stock has listed options, he can sell some options to hedge his stock
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position. To determine the quantity of options to sell, he can use the hedge ratio. The
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exact formula for the hedge ratio was given earlier in this chapter, in the section on
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the Black-Scholes pricing model. It is one of the components of the formula. Simply
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stated, the hedge ratio is merely the delta of the option - that is, the amount by which
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the option will change in price for small changes in the stock price. By selling the cor
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rect number of calls against his stock purchase, the block trader will have a neutral
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position. This position would, in theory, neither gain nor lose for small changes in the
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stock price. He is therefore buying himself time until he can unwind the position in
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the open market.
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Example: A trader buys 10,000 shares of XYZ, and a January 30 call is trading with
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a hedge ratio of .50. To have a neutral position, the trader should sell options against
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20,000 shares of stock (10,000 divided by .50 equals 20,000). Thus, he should sell 200
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of the January 30's. If the hedge ratio is correct - largely a function of the volatility
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estimate of the underlying stock - the trader will have greatly eliminated risk or
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reward on the position for small stock movements. Of course, if the block trader
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wants to assume some risk, that is a different matter. However, for the purposes of
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this discussion, the assumption is made that the block trader merely wants to facili
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tate the trade in the most risk-free manner possible. In this sample position, if the
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stock moves up by 1 point, the option should move up by ½ point. The trader would
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make $10,000 on his stock position and would lose $10,000 on his 200 short options
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- he has no gain or loss. Once the trader has the neutral position established, he can
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then begin to concentrate on unwinding the position.
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In actual practice, this hedge ratio may not work exactly, because it tends to
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change constantly as the stock price changes. If the trader finds the stock moving |