37 lines
2.9 KiB
Plaintext
37 lines
2.9 KiB
Plaintext
352 Part Ill: Put Option Strategies
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not attempt to leg out of a spread, but this is an exception to that rule, since one owns
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a long combination and therefore is protected; he is not subjecting himself to large
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risks by attempting to "leg out" of the straddle he has written.
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Example: XYZ rallies before January expiration and the January 40 put drops to a
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price of ½ during the rally. Even though there is time remaining until expiration, the
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strategist might decide to buy back the put at ½. This could potentially increase his
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overall risk by ½ point if the stock continues to rise. However, if the stock then
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reversed itself and fell, he could attempt to buy the call back at 2½ points or less. In
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this manner, he would still achieve his objective of buying the short-term straddle
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back for 3 points or less. In fact, he might be able to close both sides of the straddle
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well before near-term expiration if the underlying stock first moves quickly in one
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direction and then reverses direction by a large amount.
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The maximum risk and the optimum potential objectives have been described,
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but interim results might also be considered in this strategy.
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Example: XYZ is at 44 at January expiration. The January 40 straddle must be bought
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back for 4 points. This means that the long combination will not be owned free, but
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will have a cost of I point plus commissions. The strategist must decide at this time
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if he wants to hold on to the April options or if he wants to sell them, possibly pro
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ducing a small overall profit on the entire position. There is no ironclad rule in this
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type of situation. If the decision is made to hold on to the longer-term options, the
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strategist realizes that he has assumed additional risk by doing so. Nevertheless, he
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may decide that it is worth owning the long combination at a relatively low cost. The
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cost in this example would be I point plus commissions, since he paid 4 points to buy
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back the straddle after only taking in a 3-point credit initially. The more ex.pensive the
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buy-back of the near-term straddle is, the more the strategist should be readily will
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ing to sell his long options at the same time. For example, if XYZ were at 48 at
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January expiration and the January 40 straddle had to be bought back for 8 points,
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there should be no question that he should simultaneously sell his April options as
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well. The most difficult decisions come when the stock is just outside the optimum
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buy-back area at near-term expiration. In this example, the strategist would have a
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fairly difficult decision if XYZ were in the 44 to 45 area or in the 35 to 36 area at
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January expiration.
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The reader may recall that, in Chapter 14 on diagonalizing a spread, it was men
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tioned that one is sometimes able to own a call free by entering into a diagonal cred
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it spread. A diagonal bear spread was given as an example. The same thing happens
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to be true of a diagonal bullish put spread, since that is a credit spread as well. The |