33 lines
2.2 KiB
Plaintext
33 lines
2.2 KiB
Plaintext
to be more risk than usual of future volatility. The question remains: Is the
|
||
higher premium worth the risk?
|
||
The answer to this question is subjective. Part of the answer is based on
|
||
Stacie’s assessment of future volatility. Is the market right? The other part is
|
||
based on Stacie’s risk tolerance. Is she willing to endure the greater price
|
||
swings associated with the potentially higher volatility? This can mean
|
||
getting whipsawed, which is exiting a position after reaching a stop-loss
|
||
point only to see the market reverse itself. The would-be profitable trade is
|
||
closed for a loss. Higher volatility can also mean a higher likelihood of
|
||
getting assigned and acquiring an unwanted long stock position.
|
||
Cash-Secured Puts
|
||
There are some situations where higher implied volatility may be a
|
||
beneficial trade-off. What if Stacie’s motivation for shorting puts was
|
||
different? What if she would like to own the stock, just not at the current
|
||
market price? Stacie can sell ten 65 puts at 1.75 and deposit $63,250 in her
|
||
trading account to secure the purchase of 1,000 shares of Johnson &
|
||
Johnson if she gets assigned. The $63,250 is the $65 per share she will pay
|
||
for the stock if she gets assigned, minus the 1.75 premium she received for
|
||
the put × $100 × 10 contracts. Because the cash required to potentially
|
||
purchase the stock is secured by cash sitting ready in the account, this is
|
||
called a cash-secured put.
|
||
Her effective purchase price if assigned is $63.25—the same as her
|
||
breakeven at expiration. The idea with this trade is that if Johnson &
|
||
Johnson is anywhere under $65 per share at expiration, she will buy the
|
||
stock effectively at $63.25. If assigned, the time premium of the put allows
|
||
her to buy the stock at a discount compared with where it is priced when the
|
||
trade is established, $64. The higher the time premium—or the higher the
|
||
implied volatility—the bigger the discount.
|
||
This discount, however, is contingent on the stock not moving too much.
|
||
If it is above $65 at expiration she won’t get assigned and therefore can
|
||
only profit a maximum of 1.75 per contract. If the stock is below $63.25 at
|
||
expiration, the time premium no longer represents a discount, in fact, the
|
||
trade becomes a loser. In a way, Stacie is still selling volatility. |