40 lines
2.7 KiB
Plaintext
40 lines
2.7 KiB
Plaintext
370 Part Ill: Put Option Strategies
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1. underlying stock price,
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2. striking price,
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3. time remaining,
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4. volatility,
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5. risk-free interest rate, and
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6. dividend rate.
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The relative influence of these factors may be a little more pronounced for
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LEAPS than it is for shorter-term equity options. Consequently, the trader may think
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that a LEAPS is overly expensive or cheap by inspection, when in reality it is not. One
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should be careful in his evaluation of LEAPS until he has acquired experience in
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observing how their prices relate to the shorter-tenn equity options with which he is
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experienced.
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It might prove useful to reexamine the option pricing curve with some LEAPS
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included. Please refer to Figure 25-1 for the pricing curves of several options. As
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always, the solid intrinsic value line is the bottom line; it is the same for any call
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option. The curves are all drawn with the same values for the pertinent variables:
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stock price, striking price, volatility, short-term interest rate, and dividends. Thus,
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they can be compared directly.
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The most obvious thing to notice about the curves in Figure 25-1 is that the
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curve depicting the 2-year LEAPS is quite flat. It has the general shape of the
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shorter-term curves, but there is so much time value at stock prices even 25% in
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or out-of-the-money, that the 2-year curve is much flatter than the others.
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Other observations can be made as well. Notice the at-the-money options: The
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2-year LEAPS sells for a little more than four times the 3-month option. As we shall
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see, this can change with the effects of interest rates and dividends, but it confirms
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something that was demonstrated earlier: Time decay is not linear. Thus, the 2-year
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LEAPS, which has eight times the amount of time remaining as compared to the 3-
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month call, only sells for about four times as much. This LEAPS might appear cheap
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to the casual observer, but remember that these graphs depict the fair values for this
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set of input parameters. Do not be deluded into thinking that a LEAPS looks cheap
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merely by comparing its price to a nearer-term option; use a model to evaluate it, or
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at least use the output of someone else's model.
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The curves in Figure 25-1 depict the relationships between stock price, striking
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price, and time remaining. The most important remaining determinant of an option's
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price is the volatility of the underlying stock. Changes in volatility can greatly change
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the price of any option. This is especially true for LEAPS, since a long-term option's
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price will fluctuate greatly when volatility changes only a little. Some observations on
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the differing effects that volatility changes have on short- and long-term options are
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presented later. |