36 lines
2.8 KiB
Plaintext
36 lines
2.8 KiB
Plaintext
286 Part Ill: Put Option Strategies
|
||
never move much one way or the other, but that its net movement over the time peri
|
||
od will generally be small.
|
||
Example: If XYZ is currently at 50, one might say that its chances of being over .5.5
|
||
at the end of 90 days are fairly small, perhaps 30%. This may even be supported by
|
||
mathematical analysis based on the volatility of the underlying stock. This does not
|
||
imply, however, that the stock has only a 30% chance of ever reaching 55 during the
|
||
90-day period. Rather, it implies that it has only a 30% chance of being over 55 at the
|
||
end of the 90-day period. These are two distinctly different events, with different
|
||
probabilities of occurrence. Even though the probability of being over 55 at the end
|
||
of 90 days might be only 30%, the probability of ever being over 55 during the 90-
|
||
day period could be amazingly high, perhaps as high as 80%. It is important for the
|
||
straddle buyer to understand the differences between these events occurring, for he
|
||
might often be able to take follow-up action to improve his position.
|
||
Many times, after a straddle is bought, the underlying stock will begin to move
|
||
strongly, making it appear that the straddle is immediately going to become prof
|
||
itable. However, just as things are going well, the stock reverses and begins to change
|
||
direction, perhaps so quickly that it would now appear that the straddle will become
|
||
profitable on the other side. These volatile stock movements often result in little net
|
||
change, however, and at expiration the straddle buyer may have a loss. One might
|
||
think that he would take profits on the call side when they became available in a
|
||
quick upward movement, and then hope for a downward reversal so that he could
|
||
take profits on the put side as well. Taking small profits, however, is a poor strategy.
|
||
Straddle buying has limited losses and potentially unlimited profits. One might have
|
||
to suffer through a substantial number of small losses before hitting a big winner, but
|
||
the magnitude of the gain on that one large stock movement can offset many small
|
||
losses. By taking small profits, the straddle buyer is immediately cutting off his
|
||
chances for a substantial gain; that is why it is a poor strategy to limit the profits.
|
||
This is one of those statements that sounds easier in theory than it is in practice.
|
||
It is emotionally distressing to watch the straddle gain 2 or 3 points in a short time
|
||
period, only to lose that and more when the stock fails to follow through. By using a
|
||
different example, it is possible to demonstrate the types of follow-up action that the
|
||
straddle buyer might take.
|
||
Example: One had initially bought an XYZ January 40 straddle for 6 points when the
|
||
stock was 40. After a fairly short time, the stock jumps up to 45 and the following
|
||
prices exist: |