38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
0.,ter 14: Diagonalizing a Spread 241
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Any type of spread may be diagonalized. There are some who prefer to diago
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nalize even butterfly spreads, figuring that the extra time to maturity in the purchased
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calls will be of benefit. Overall, the benefits of diagonalizing can be generalized by
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recalling the way in which the decay of the time value premium of a call takes place.
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Recall that it was determined that a call loses most of its time value premium in the
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last stages of its life. When it is a very long-term option, the rate of decay is small.
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Knowing this fact, it makes sense that one would want to sell options with a short life
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remaining, so that the maximum benefit of the decay could be obtained.
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Correspondingly, the purchase of a longer-term call would mean that the buyer is not
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subjecting himself to a substantial loss in time value premium, at least over the first
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three months of ownership. A diagonal spread encompasses both of these features -
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selling a short-term call to try to obtain the maximum rate of time decay, while buy
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ing a longer-term call to try to lessen the effect of time decay on the long side.
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CALL OPTION SUMMARY
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This concludes the description of strategies that utilize only call options. The call
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option has been seen to be a vehicle that the astute strategist can use to set up a wide
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variety of positions. He can be bullish or bearish, aggressive or conservative. In addi
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tion, he can attempt to be neutral, trying to capitalize on the probability that a stock
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will not move very far in a short time period.
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The investor who is not familiar with options should generally begin with a sim
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ple strategy, such as covered call writing or outright call purchases. The simplest
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types of spreads are the bull spread, the bear spread, and the calendar spread. The
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more sophisticated investor might consider using ratios in his call strategies - ratio
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writing against stock or ratio spreading using only calls.
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Once the strategist feels that he understands the risk and reward relationships
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between longer-term and short-term calls, between in-the-money and out-of-the
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money calls, and between long calls and short calls, he could then consider utilizing
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the most advanced types of strategies. This might include reverse ratio spreads, diag
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onal spreads, and more advanced types of ratios, such as the ratio calendar spread.
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A great deal of information, some of it rather technical in detail, has been pre
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sented in preceding chapters. The best pattern for an investor to follow would be to
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attempt only strategies that he fully comprehends. This does not mean that he mere
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ly understands the profitability aspects (especially the risk) of the strategy. One must
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also be able to readily understand the potential effects of early assignments, large div
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idend payments, striking price adjustments, and the like, if he is going to operate
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advanced strategies. Without a full understanding of how these things might affect
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one's position, one cannot operate an advanced strategy correctly. |