38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
Chapter 40: Advanced Concepts 847
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Most option strategies fall into one of two categories: as a hedge to a stock or
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futures strategy (for example, buying puts to protect a portfolio of stocks), or as a
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profit venture unto itself. The latter category is where most traders find themselves,
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and they often approach it in a fairly speculative manner - either by buying options
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or by being a premium seller (covered or uncovered). In such strategies, the trader
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is taking a view of the market; he needs certain price action from the underlying
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security in order to profit. Even covered call writing, which is considered to be a con
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servative strategy, is subject to large losses if the underlying stock drops drastically.
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It doesn't have to be that way. Strategies can be devised that will have a chance
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to profit regardless of price changes in the underlying stock, as well as because of
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them. Such strategies are neutral strategies and they always require at least two
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options in the position - a spread, straddle, or some other combination. Often, when
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one constructs a neutral strategy, he is neutral with respect to price changes in the
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underlying security. It is also possible, and often wise, to be neutral with respect to
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the rate of price change of the underlying security, with respect to the volatility of
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the security, or with respect to time decay. This is not to imply that any option spread
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that is neutral will automatically be a money-maker; rather, one looks for an
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opportunity - perhaps an overpriced series of options - and attempts to capture that
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overpricing by constructing a neutral strategy around it. Then, regardless of the
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movement of the underlying stock, the strategist has a chance of making money if the
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overpricing disappears.
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Note that the neutral approach is distinctly different from the speculator's, who,
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upon determining that he has discovered an underpriced call, would merely buy the
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call, hoping for the stock to increase in price. He would not make money if XYZ fell
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in price unless there was a huge expansion in implied volatility - not something to
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count on. The next section of this chapter deals with how one determines his neu
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trality. In effect, if he is not neutral, then he has risk of some sort. The following sec
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tions outline various measures of risk that the strategist can use to establish a new
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position or manage an existing one.
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The most important of these risk measurements is how much market exposure
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the position currently has. This has previously been described as the "delta." Of near
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ly equal importance to the strategist is how much the option strategy will change with
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respect to the rate of change in the price of the underlying security. Also of interest
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are how changes in volatility, in time remaining until expiration, or even in the risk
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free interest rate will affect the position. Once the components of the option position
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are defined, the strategist can then take action to reduce the risk associated with any
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of the factors, should he so desire. |