35 lines
2.4 KiB
Plaintext
35 lines
2.4 KiB
Plaintext
Gaining Exposure • 207
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that if the option expires when the stock price is at either edge of my valu-
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ation range, it is far enough in-the-money to pay me back for both legs of
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the investment (plus an attractive return).
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Portfolio Management
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As mentioned earlier, this is naturally a more speculative style of option
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investment, and it may well be more beneficial to close the successful leg of
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the strategy before expiration than to hold the position to expiration. Com-
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pared with the next strategy presented here (the straddle), the strangle ac-
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tually generates worse returns if held to expiration, so if you are happy with
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your returns midway through the investment, you should close the posi-
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tion rather than waiting for expiration. The exception to this rule is that if
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news comes out that convinces you that the value of the firm is materially
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higher or lower than what you had originally forecast and uncertainty in
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the other direction has been removed, you should assess the possibility of
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making a more substantial investment in the company.
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One common problem with investors—even experienced and sophis-
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ticated ones—is that they check the past price history of a stock and decide
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whether the stock has “more room” to move in a particular direction. The
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most important two things to know when considering an investment are its
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value and the uncertainty surrounding that value. Whether the stock was
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cheaper three years ago or much more expensive does not matter—these are
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backward-looking measures, and you cannot invest with a rear-view mirror.
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One final note regarding this strategy is what to do with the unused
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leg. If the stock moves up strongly and you take profits on the call, what
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should you do with the put, in other words. Unfortunately, the unused leg is
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almost always worthless, and often it will cost more than it’s worth to close
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it. I usually keep this leg open because you never know what may happen,
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and perhaps before it expires, you will be able to close it at a better price.
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This is a speculative strategy—a bit of spice or an after-dinner mint
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in the meal of investing. Don’t expect to get rich using it (if you do get rich
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using it, it means that you were lucky because you would have had to have
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used a lot of leverage in the process), but you may be pleasantly surprised
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with the boost you get from these every once in a while.
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Let’s now turn briefly to a related strategy—the straddle. |