37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
ter 18: Buying Puts in Conjunction with Call Purchases
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IILECTING A STRADDLE BUY
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285
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In theory, one could find the best straddle purchases by applying the analyses for best
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call purchases and best put purchases simultaneously. Then, if both the puts and calls
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on a particular stock showed attractive opportunity, the straddle could be bought.
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The straddle should be viewed as an entire position. A similar sort of analysis to that
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proposed for either put or call purchases could be used for straddles as well. First,
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one would assume the stock would move up or down in accordance with its volatili
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ty within a fixed time period, such as 60 or 90 days. Then, the prices of both the put
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and the call could be predicted for this stock movement. The straddles that off er the
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best reward opportunity under this analysis would be the most attractive ones to buy.
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To demonstrate this sort of analysis, the previous example can be utilized again.
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Example: XYZ is at 50 and the July 50 call is selling for 3 while the July 50 put is sell
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ing for 2 points. If the strategist is able to determine that XYZ has a 25% chance of
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being above 54 in 90 days and also has a 25% chance of being below 46 in 90 days,
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he can then predict the option prices. A rigorous method for determining what per
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centage chance a stock has of making a predetermined price movement is presented
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in Chapter 28 on mathematical applications. For now, a general procedure of analy
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sis is more important than its actual implementation. If XYZ were at 54 in 90 days, it
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might be reasonable to assume that the call would be worth 5½ and the put would
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be worth 1 point. The straddle would therefore be worth 6½ points. Similarly, if the
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stock were at 46 in 90 days, the put might be worth 4½ points, and the call worth 1
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point, making the entire straddle worth 5½ points. It is fairly common for the strad
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dle to be higher-priced when it is a fixed distance in-the-money on the call side (such
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as 4 points) than when it is in-the-money on the put side by that same distance. In
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this example, the strategist has now determined that there is a 25% chance that the
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straddle will be worth 6½ points in 90 days on an upside movement, and there is a
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25% chance that the straddle will be worth 5½ points on a downside movement. The
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average price of these two expectations is 6 points. Since the straddle is currently sell
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ing for 5 points, this would represent a 20% profit. If all potential straddles are
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ranked in the same manner - allowing for a 25% chance of upside and downside
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movement by each underlying stock - the straddle buyer will have a common basis
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for comparing various straddle opportunities.
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FOLLOW-UP ACTION
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It has been mentioned frequently that there is a good chance that a stock will remain
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relatively unchanged over a short time period. This does not mean that the stock will |