39 lines
3.1 KiB
Plaintext
39 lines
3.1 KiB
Plaintext
Chapter 42: The Best Strategy? 933
|
||
is generally called volatility trading. If the net change in the market is small over a
|
||
period of time, these strategies should perform well: ratio writing, ratio spreading
|
||
(especially "delta neutral spreads"), straddle and strangle writing, neutral calendar
|
||
spreading, and butterfly spreads. On the other hand, if options are cheap and the
|
||
market is expected to be volatile, then these would be best: straddle and strangle
|
||
buys, backspreads, and reverse hedges and spreads.
|
||
Certain other strategies overlap into more than one of the three broad
|
||
categories. For example, the bullish or bearish calendar spread is initially a neutral
|
||
position. It only assumes a bullish or bearish bias after the near-term option expires.
|
||
In fact, any of the diagonal or calendar strategies whose ultimate aim is to generate
|
||
profits on the sale of shorter-term options are similar in nature. If these near-term
|
||
profits are generated, they can offset, partially or completely, the cost oflong options.
|
||
Thus, one might potentially own options at a reduced cost and could profit from a
|
||
definitive move in his favor at the right time. It was shown in Chapters 14, 23, and
|
||
24 that diagonalizing a spread can often be very attractive.
|
||
This brief grouping into three broad categories, does not cover all the strategies
|
||
that have been discussed. For example, some strategies are generally to be avoided
|
||
by most investors: high-risk naked option writing (selling options for fractional prices)
|
||
and covered or ratio put writing. In essence, the investor will normally do best with
|
||
a position that has limited risk and the potential of large profits. Even if the profit
|
||
potential is a low-probability event, one or two successful cases may be able to over
|
||
come a series of limited losses. Complex strategies that fit this description are the
|
||
diagonal put and call combinations described in Chapters 23 and 24. The simplest
|
||
strategy fitting this description is the T-bill/option purchase program described in
|
||
Chapter 26.
|
||
Finally, many strategies may be implemented in more than one way. The
|
||
method of implementation may not alter the profit potential, but the percentage risk
|
||
levels can be substantially different. Equivalent strategies fit into this category.
|
||
Example: Buying stock and then protecting the stock purchase with a put purchase
|
||
is an equivalent strategy in profit potential to buying a call. That is, both have limit
|
||
ed dollar risk and large potential dollar profit if the stock rallies. However, they are
|
||
substantially different in their structure. The purchase of stock and a put requires
|
||
substantially more initial investment dollars than does the purchase of a call, but the
|
||
limited dollar risk of the strategy would normally be a relatively small percentage of
|
||
the initial investment. The call purchase, on the other hand, involves a much small
|
||
er capital outlay; in addition, while it also has limited dollar risk, the l~ss may easily
|
||
represent the entire initial investment. The stockholder will receive cash dividends
|
||
while the call holder will not. Moreover, the stock will not expire as the call will. This |