35 lines
2.3 KiB
Plaintext
35 lines
2.3 KiB
Plaintext
Chapter 3: Call Buying 101
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Example: If XYZ is 4 7½ and the call buyer expects a quick, but possibly limited, rise
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in price in the underlying stock, should he buy the 45 call or the 50 call? The delta
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may help him decide. He has the following information:
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XYZ: 471/2 XYZ July 45 call: price = 31/2,
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XYZ July 50 call: price = 1,
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delta = 5/a
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delta = 1/4
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It will make matters easier to make a slightly incorrect, but simplifying, assumption
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that the deltas remain constant over the short term. Which call is the better buy if
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the buyer expects the stock to quickly rise to 49? This would represent a 1 ½-point
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increase in XYZ, which would translate into a 15/16 increase in the July 45 (l½ times
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5/s) or a 3/s increase in the July 50 (1 ½ times ¼). Consequently, the July 45, if it
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increased in price by 15/16, would appreciate by 27%. The July 50, if it increased by
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3/a, would appreciate by over 37%. Thus, the July 50 appears to be the better buy in
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this simple example. Commissions should, of course, be included when making an
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analysis for actual investment.
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The investor does not have to bother with computing deltas for himself. Any
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good call-buying data service will supply the information, and some brokerage hous
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es provide this information free of charge.
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More advanced applications of deltas are described in many of the succeeding
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chapters, as they apply to a variety of strategies.
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WHICH OPTION TO BUY?
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There are various trading strategies, some short-term, some long-term (even buy and
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hold). If one decides to use an option to implement a trading strategy, the time hori
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zon of the strategy itself often dictates the general category of option that should be
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bought - in-the-money versus out-of-the-money, near-term versus long-term, etc.
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This statement is true whether one is referring to stock, index, or futures options.
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The general rule is this: The shorter-term the strategy, the higher the delta should be
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of the instrument being used to trade the strategy.
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DAY TRADING
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For example, day trading has become a popular endeavor. Statistics have been pro
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duced that indicate that most day traders lose money. In fact, there are profitable day
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traders; it simply requires more and harder work than many are willing to invest.
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Many day traders have attempted to use options in their strategies. These day traders |