40 lines
3.2 KiB
Plaintext
40 lines
3.2 KiB
Plaintext
436 Part IV: Additional Considerations
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If one is truly undecided about whether he will be assigned on his short puts,
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he might look at several clues. First, has any late news come out on Friday evening
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that might affect the market's opening or the stock's opening on Monday morning? If
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so, that should be factored into the decision regarding exercising the calls. Another
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clue arises from the price at which the stock was trading during the Friday expiration
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day, prior to the close. If the stock was below the strike for most of the day before
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closing at the strike, then there is a greater chance that the puts will be assigned. This
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is so because other arbitrageurs (discounters) have probably bought puts and bought
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stock during the day and will exercise to clean out their positions.
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If there is still doubt, it may be wisest to exercise only half of the calls, hoping
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for a partial assignment on the puts (always a possibility). This halfway measure will
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normally result in some sort of unhedged stock position on Monday morning, but it
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will be smaller than the maximum exposure by at least half.
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Another approach that the arbitrageur can take if the stock is near the strike of
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the reversal during the late trading of the options' life - during the last few days - is
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to roll the reversal to a later expiration or, failing that, to roll to another strike in the
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same expiration. First, let us consider rolling to another expiration. The arbitrageur
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knows the dollar price that equals his effective rate for a 3-month reversal. If the cur
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rent options can be closed out and new options opened at the next expiration for at
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least the effective rate, then the reversal should be rolled. This is not a likely event,
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mostly due to the fact that the spread between the bid and asked prices on four sep
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arate options makes it difficult to attain the desired price. Note: This entire four-way
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order can be entered as a spread order; it is not necessary to attempt to "leg" the
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spread.
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The second action - rolling to another strike in the same expiration month -
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may be more available. Suppose that one has the July 45 reversal in place (long July
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45 call and short July 45 put). If the underlying stock is near 45, he might place an
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order to the exchange floor as a three-way spread: Sell the July 45 call (closing), buy
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the July 45 put (closing), and sell the July 40 call ( opening) for a net credit of 5 points.
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This action costs the arbitrageur nothing except a small transaction charge, since he
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is receiving a 5-point credit for moving the strike by 5 points. Once this is accom
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plished, he will have moved the strike approximately 5 points away and will thus have
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avoided the problem of the stock closing at the strike.
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Overall, these four risks are significant, and reversal arbitrageurs should take
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care that they do not fall prey to them. The careless arbitrageur uses effective rates
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too close to current market rates, establishes reversals with puts in-the-money, and
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routinely accepts the risk of acquiring an unhedged stock position on the morning
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after expiration. He will probably sustain a large loss at some time. Since many rever
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sal arbitrageurs work with small capital and/or have convinced their backers that it is |