38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
Chapter 23: Spreads Combining Calls and Puts 351
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The potential results from this position may vary widely. However, the risk is
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limited before near-tenn expiration. If the underlying stock should advance substan
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tially before January expiration, the puts would be nearly worthless and the calls
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would both be trading near parity. With the calls at parity, the strategist would have
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to pay, at most, 5 points to close the call spread, since the striking prices of the calls
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are 5 points apart. In a similar manner, if the underlying stock had declined substan
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tially before the near-term January options expired, the calls would be nearly worth
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less and the puts would be at parity. Again, it would cost a maximum of 5 points to
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close the put spread, since the difference in the striking prices of the puts is also 5
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points. The worst result would be a 2-point loss in this example - 3 points of credit
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were initially received, and the most that the strategist would have to pay to close the
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position is 5 points. This is the theoretical risk. In actual practice, it is very unlikely
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that the calls would trade as much as 5 points apart, even if the underlying stock
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advanced by a large amount, because the longer-term call should retain some small
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time value premium even if it is deeply in-the-money. A similar analysis might apply
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to the puts. The risk can always be quickly computed as being equal to the difference
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between two contiguous striking prices ( two strikes next to each other), less the net
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credit received.
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The strategist's objective with this position is to be able to buy back the near
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tenn straddle for a price less than the original credit received. If he can do this, he
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will own the longer-term combination for free.
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Example: Near January expiration, the strategist is able to repurchase the January 40
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straddle for 2 points. Since he initially received a 3-point credit and is then able to
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buy back the written straddle for 2 points, he is left with an overall credit in the posi
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tion of 1 point, less commissions. Once he has done this, the strategist retains the
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long options, the April 35 put and April 45 call. If the underlying stock should then
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advance substantially or decline substantially, he could make very large profits.
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However, even if the long combination expires worthless, the strategist still makes a
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profit, since he was able to buy the straddle back for less than the amount of the orig
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inal credit.
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In this example, the strategist's objective is to buy back the January 40 straddle
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for less than 3 points, since that is the amount of the initial credit. At expiration, this
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would mean that the stock would have to be between 37 and 43 for the buy-back to
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be made for 3 points or less. Although it is possible, certainly, that the stock will be
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in this fairly narrow range at near-term expiration, it is not probable. However, the
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strategist who is willing to add to his risk slightly can often achieve the same result by
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"legging out" of the January 40 straddle. It has repeatedly been stated that one should |