37 lines
2.9 KiB
Plaintext
37 lines
2.9 KiB
Plaintext
420 Part IV: Additional Considerations
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ever, to assume that the risk in holding a call option is less than 100% in a holding
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period as short as 30 days. The strategist may feel that he is disciplined enough to sell
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out when losses occur and thereby hold the risk to less than 100%. Alternatively,
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mathematical analysis will generally show that the expected loss in a fixed time peri
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od is less than 100%. One can also mitigate the probability oflosing all of his money
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in an option purchase by buying in-the-money options. While they are more expen
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sive, of course, they do have a larger probability of having some residual worth even
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if the underlying stock doesn't rise to the trader's expectations. Adhering to any of
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these criteria can lead one to become too aggressive and therefore be too heavily
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committed to option purchases. It is far safer to stick to the simpler, more restrictive
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assumption that one is risking all his money, even over a fairly short holding period,
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when he buys an option.
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AVOIDING EXCESSIVE RISK
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One final word of caution must be inserted. The investor should not attempt to
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become 'Janey" with the income-bearing portion of his assets. T-bills may appear to
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be too "tame" to some investors, and they consider using GNMA's (Government
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National Mortgage Association certificates), corporate bonds, convertible bonds, or
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municipal bonds for the fixed-income portion. Although the latter securities may
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yield a slightly higher return than do T-bills, they may also prove to be less liquid and
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they quite clearly involve more risk than a short-term T-bill does. Moreover, some
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investors might even consider placing the balance of their funds in other places, such
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as high-yield stock or covered call writing. While high-yield stock purchases and cov
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ered call writing are conservative investments, as most investments go, they would
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have to be considered very speculative in comparison to the purchase of a 90-day T
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hill. In this strategy, the profit potential is represented by the option purchases. The
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yield on short-term T-bills will quite adequately offset the risks. One should take
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great care not to attempt to generate much higher yields on the fixed-income portion
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of his investment, for he may find that he has assumed risk with the portion of his
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money that was not intended to have any risk at all.
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A fair amount of rigorous mathematical work has been done on the evaluation
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of this strategy. The theoretical papers are quite favorable. Scholars have generally
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considered only the purchase of call options as the risk portion of the strategy.
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Obviously, the strategist is quite free to purchase put options without harming the
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overall intent of the strategy. When only call options are purchased, both static and
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down markets harm the performance. If some puts are included in the option pur
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chases, only static markets could produce the worst results. |