36 lines
2.2 KiB
Plaintext
36 lines
2.2 KiB
Plaintext
228 • The Intelligent Option Investor
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With a table like this, you can balance, on the one hand, the degree
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you are reducing your overall exposure in a worst-case scenario (by look-
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ing at column a) against how much risk you are taking on for a bad-case
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(intermediary upward move of the stock) scenario (by looking at column
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b) against how much less premium you stand to earn if the stock does go
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down as expected (by looking at column c).
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There are no hard and fast rules for which is the correct covering strike to
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select—that will depend on your confidence in the valuation and timing, your
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risk profile, and the position size—but looking at the table, I tend to be drawn
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to the $215 and $220 strikes. With both of those strikes, you are reducing your
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worst-case exposure by about half, increasing your bad-case exposure just
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marginally, and taking only a small haircut on the premium you are receiving.
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6
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Now that we have an idea of how to think about the potential risk and
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return on a per-contract basis, let’s turn to leverage in the strategic sense—
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figuring out how much capital to commit to a given bearish idea.
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Portfolio Management
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When we thought about leverage from a call buyer’s perspective, we
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thought about how large of an allocation we wanted to make to the idea
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itself and changed our leverage within that allocation to modify the profits
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we stood to make. Let’s do this again with IBM—again assuming that we are
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willing to allocate 5 percent of our portfolio to an investment in the view
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that this company’s stock price will not go higher. At a price of $196.80, a
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5 percent allocation would mean controlling a little more than 25 shares for
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every $100,000 of portfolio value.
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7 Because options have a contract size of
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100 shares, an unlevered 5 percent allocation to this investment would
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require a portfolio size of $400,000.
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The equation to calculate the leverage ratio on the basis of notional
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exposure is
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× =Notional valueo fo ne contract
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Dollarv alue of allocation number of contractsl everager atio
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So, for instance, if we had a $100,000 portfolio of which we were willing to
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commit 5 percent to this short-call spread on IBM, our position would have a
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leverage ratio of |