42 lines
2.6 KiB
Plaintext
42 lines
2.6 KiB
Plaintext
Chapter 20: The Sale of a Straddle 319
|
||
deltas of the options involved in his position to determine a neutral ratio. The strad
|
||
dle writer can do the same thing, of course. It was stated that the difference between
|
||
a call's delta and a put' s delta is approximately one. Using the same prices as in the
|
||
previous straddle writing example, and assuming the call's delta to be .60, a neutral
|
||
ratio can be determined.
|
||
Prices
|
||
XYZ common:
|
||
XYZ January 45 call:
|
||
XYZ January 45 put:
|
||
45
|
||
4
|
||
3
|
||
Deltas
|
||
.60
|
||
-.40 (.60 - 1)
|
||
The put has a negative delta, to indicate that the put and the underlying stock are
|
||
inversely related. A neutral ratio is determined by dividing the call's delta by the put's
|
||
delta and ignoring the minus sign. The resultant ratio - 1.5:1 (.60/.40) in this case -
|
||
is the ratio of puts to sell for each call that is sold. Thus, one should sell 3 puts and
|
||
sell 2 calls to establish a neutral position. The reader may wonder if the assumption
|
||
that an at-the-money call has a delta of .60 is a fair one. It generally is, although very
|
||
long-term calls will have higher at-the-money deltas, and very short-term calls will
|
||
have deltas near .50. Consequently, a 3:2 ratio is often a neutral one. When neutral
|
||
ratios were discussed with respect to ratio writing, it was mentioned that selling 5
|
||
calls and buying 300 shares of stock often results in neutral ratio. The reader should
|
||
note that a straddle constructed by selling 3 puts and 2 calls is equivalent to the ratio
|
||
write in which one sells 5 calls and buys 300 shares of stock.
|
||
If a straddle writer is going to use the deltas to determine his neutral ratio, he
|
||
should compute each one at the time of his initial investment, of course, rather than
|
||
relying on a generality such as that 3 puts and 2 calls often result in a neutral posi
|
||
tion. The deltas can be used as a follow-up action, by adjusting the ratio to remain
|
||
neutral after a move by the underlying stock.
|
||
AVOID EXCESS TRADING
|
||
In any of the straddle and strangle writing strategies described above, too much fol
|
||
low-up action can be detrimental because of the commission costs involved. Thus,
|
||
although it is important to take protective action, the straddle writer should plan in
|
||
advance to make the minimum number of strategic moves to protect himself. That is
|
||
why buying protection is often useful; not only does it limit the risk in the direction
|
||
that the stock is moving, but it also involves only one additional option commission.
|
||
In fact, if it is feasible, buying protection at the outset is often a better strategy than
|
||
protecting as a secondary action. |