35 lines
2.7 KiB
Plaintext
35 lines
2.7 KiB
Plaintext
Chpter 3: Call Buying 107
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away that portion of the option's price as expiration approaches. However, when an
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option has a considerable amount of time remaining until its expiration, the more
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important component of the option value is really volatility. If traders expect the
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underlying stock to be volatile, the option will be expensive; if they expect the oppo
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site, the option will be cheap. This expensiveness and cheapness is reflected in the
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portion of the option that is not intrinsic value. For example, a six-month option will
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not decay much in one day's time, but a quick change in volatility expectations by
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option traders can heavily affect the price of the option, especially one with a good
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deal of time remaining. So an option buyer should carefully assess his purchases, not
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just view them as something that will waste away. With careful analysis, option buy
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ers can do very well, if they consider what can happen during the life of the option,
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and not merely what will happen at expiration.
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CALL BUYERS' FRUSTRATIONS
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Despite one's best efforts, it may often seem that one does not make much money
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when a fairly volatile stock makes a quick move of 3 or 4 points. The reasons for this
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are somewhat more complex than can be addressed at this time, although they relate
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strongly to delta, time decay, and the volatility of the underlying stock. They are dis
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cussed in Chapter 36, 'The Basics of Volatility Trading." If one plans to conduct a
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serious call buying strategy, he should read that chapter before embarking on a pro
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gram of extensive call buying.
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FOLLOW-UP ACTION
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The simplest follow-up action that the call buyer can implement when the underly
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ing stock drops is to sell his call and cut his losses. There is often a natural tendency
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to hold out hope that the stock can rally back to or above the striking price. Most of
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the time, the buyer does best by cutting his losses in situations in which the stock is
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performing poorly. He might use a "mental" stop price or could actually place a sell
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stop order, depending on the rules of the exchange where the call is traded. In gen
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eral, stop orders for options result in poor executions, so using a "mental" stop is bet
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ter. That is, one should base his exit point on the technical pattern of the underlying
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stock itself. If it should break down below support, for example, then the option
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holder should place a market (not held) order to sell his call option.
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If the stock should rise, the buyer should be willing to take profits as well. Most
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buyers will quite readily take a profit if, for example, a call that was bought for 5
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points had advanced to be worth 10 points. However, the same investor is often |