38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
218 Part II: Call Option Strategies
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REDUCING THE RATIO
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Upside fallow-up action does not normally consist of rolling up as it does in a ratio
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write. Rather, one should usually buy some more long calls to reduce the ratio in the
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spread. Eventually, he would want to reduce the spread to 1:1, or a normal bull
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spread. An example may help to illustrate this concept.
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Example: In the initial example, one April 40 call was bought and two April 45's were
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sold, for a net credit of one point. Assume that the spreader is going to buy one more
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April 40 as a means of upside defensive action if he has to. When and if he buys this
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second long call, his total position will be a normal bull spread - long 2 April 40's and
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short 2 April 45's. The liquidating value of this bull spread would be 10 points if XYZ
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were above 45 at April expiration, since each of the two bull spreads would widen to
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its maximum potential (5 points) with the stock above 45 in April. The ratio spread
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er originally brought in a one-point credit for the 2:1 spread. If he were later to pay
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11 points to buy the additional long April 40 call, his total outlay would have been 10
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points. This would represent a break-even situation at April expiration if XYZ were
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above 45 at that time, since it was just shown that the spread could be liquidated for
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10 points in that case. So the ratio spreader could wait to take defensive action until
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the April call was selling for 11 points. This is a dynamic type of follow-up action, one
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that is dependent on the options' price, not the stock price per se.
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This outlay of 11 points for the April 40 would leave a break-even situation as
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long as the stock did not reverse and fall in price below 45 after the call was bought.
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The spreader may decide that he would rather leave some room for upside profit
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rather than merely trying to break even if the stock rallies too far. He might thus
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decide to buy the additional long call at 9 or 10 points rather than waiting for it to get
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to 11. Of course, this might increase the chances of a whipsaw occurring, but it would
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leave some room for upside profits if the stock continues to rise.
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Where ratios other than 2:1 are involved initially, the same thinking can be
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applied. In fact, the purchase of the additional long calls might take place in a two
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step process.
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Example: If the spread was initially long 5 calls and short 10 calls, the spreader
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would not necessarily have to wait until the April 40's were selling at 11 and then buy
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all 5 needed to make the spread a normal bull spread. He might decide to buy 2 or
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3 at a lower price, thereby reducing his ratio somewhat. Then, if the stock rallied
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even further, he could buy the needed long calls. By buying a few at a cheaper price,
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the spreader gives himself the leeway to wait considerably longer to the upside. In
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essence, all 5 additional long calls in this spread would have to be bought at an aver
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age price of 11 or lower in order for the spread to break even. However, if the first 2 |