36 lines
2.7 KiB
Plaintext
36 lines
2.7 KiB
Plaintext
176 Part II: Call Option Strategies
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mission costs in this spread would be substantially larger than those in the spreads
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above, which involve less expensive options initially, and they should therefore be fig
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ured into one's profit calculations before entering into the spread transaction. Since
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this stock would have to decline 7 points to fall below 30 and cause a loss of the entire
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investment, it would have to be considered a rather low-probability event. This fact
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adds to the less aggressive nature of this type of spread.
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RANKING BULL SPREADS
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To accurately compare the risk and reward potentials of the many bull spreads that
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are available in a given day, one has to use a computer to perform the mass calcula
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tions. It is possible to use a strictly arithmetic method of ranking bull spreads, but
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such a list will not be as accurate as the correct method of analysis. In reality, it is
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necessary to incorporate the volatility of the underlying stock, and possibly the
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expected return from the spread as well, into one's calculations. The concept of
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expected return is described in detail in Chapter 28, where a bull spread is used as
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an example.
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The exact method for using volatility and predicting an option's price after an
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upward movement are presented later. Many data services offer such information.
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However, if the reader wants to attempt a simpler method of analysis, the following
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one may suffice. In any ranking of bull spreads, it is important not to rank the spreads
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by their maximum potential profits at expiration. Such a ranking will always give the
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most weight to deeply out-of-the-money spreads, which can rarely achieve their max
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imum profit potential. It would be better to screen out any spreads whose maximum
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profit prices are too far away from the current stock price. A simple method of allow
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ing for a stock's movement might be to assume that the stock could, at expiration,
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advance by an amount equal to twice the time value premium in an at-the-money
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call. Since more volatile stocks have options with greater time value premium, this is
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a simple attempt to incorporate volatility into the analysis. Also, since longer-term
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options have more time value premium than do short-term options, this will allow for
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larger movements during a longer time period. Percentage returns should include
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commission costs. This simple analysis is not completely correct, but it may prove
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useful to those traders looking for a simple arithmetic method of analysis that can be
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computed quickly.
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FURTHER CONSIDERATIONS
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The bull spreads described in previous examples utilize the same expiration date for
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both the short call and the long call. It is sometimes useful to buy a call with a longer |