38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
254 Part Ill: Put Option Strategies
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A conversion position has no risk. The arbitrageur will do three things:
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1. Buy 100 shares of the underlying stock.
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2. Buy 1 put option at a certain striking price.
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3. Sell l call option at the same striking price.
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The arbitrageur has no risk in this position. If the underlying stock drops, he can
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always exercise his long put to sell the stock at a higher price. If the underlying stock
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rises, his long stock offsets the loss on his short call. Of course, the prices that the
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arbitrageur pays for the individual securities determine whether or not a conversion
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will be profitable. At times, a public customer may look at prices in the newspaper
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and see that he could establish a position similar to the foregoing one for a profit,
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even after commissions. However, unless prices are out of line, the public customer
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would not normally be able to make a better return than he could by putting his
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money into a bank or a Treasury bill, because of the commission costs he would pay.
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Without needing to understand, at this time, exactly what prices would make an
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attractive conversion, it is possible to see that it would not always be possible for the
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arbitrageur to do a conversion. The mere action of many arbitrageurs doing the same
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conversion would force the prices into line. The stock price would rise because arbi
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trageurs are buying the stock, as would the put price; and the call price would drop
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because of the preponderance of sellers.
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When this happens, another arbitrage, known as a reversal ( or reverse conver
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sion), is possible. In this case, the arbitrageur does the opposite: He shorts the under
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lying stock, sells 1 put, and buys 1 call. Again, this is a position with no risk. If the
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stock rises, he can always exercise his call to buy stock at a lower price and cover his
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short sale. If the stock falls, his short stock will offset any losses on his short put.
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The point of introducing this information, which is relatively complicated, at
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this place in the text is to demonstrate that there is a relationship between put and
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call prices, when both have the same striking price and expiration date. They are not
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independent of one another. If the put becomes "cheap" with respect to the call, arbi
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trageurs will move in to do conversions and force the prices back in line. On the other
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hand, if the put becomes expensive with relationship to the call, arbitrageurs will do
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reversals until the prices move back into line.
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Because of the way in which the carrying cost of the stock and the dividend rate
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of the stock are involved in doing these conversions or reversals, two facts come to
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light regarding the relationship of put prices and call prices. Both of these facts have
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to do with the carrying costs incurred during the conversion. First, a put option will
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generally sell for less than a call option when the underlying stock is exactly at the
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striking price, unless the stock pays a large dividend. In the older over-the-counter |