36 lines
2.8 KiB
Plaintext
36 lines
2.8 KiB
Plaintext
Chapter 11: Ratio Call Spreads 217
|
||
It is a fairly simple matter to determine the correct ratio to use in the delta
|
||
spread: Merely divide the delta of the purchased call by the delta of the written call.
|
||
In the example, this implies that the neutral ratio is .80 divided by .50, or 1.6:1.
|
||
Obviously, one cannot sell 1.6 calls, so it is common practice to express that ratio as
|
||
16:10. Thus, the neutral spread would consist of buying 10 April 40's and selling 16
|
||
April 45's. This is the same as an 8:5 ratio. Notice that this calculation does not
|
||
include anything about debits or credits involved in the spread. In this example, an
|
||
8:5 ratio would involve a small debit of one point (5 April 40's cost 25 points and 8
|
||
April 45's bring in 24 points). Generally, reasonably selected delta spreads involve
|
||
small debits.
|
||
Certain selection criteria can be offered to help the spreader eliminate some of
|
||
the myriad possibilities of delta spreads on a day-to-day basis. First, one does not
|
||
want the ratio of the spread to be too large. An absolute limit, such as 4:1, can be
|
||
placed on all spread candidates. Also, if one eliminates any options selling for less
|
||
than ½ point as candidates for the short side of the spread, the higher ratios will be
|
||
eliminated. Second, one does not want the ratio to be too small. If the delta-neutral
|
||
ratio is less than 1.2:1 (6:5), the spread should probably be rejected. Finally, if one is
|
||
concerned with downside risk, he might want to limit the total debit outlay. This
|
||
might be done with a simple parameter, such as not paying a debit of more than 1
|
||
point per long option. Thus, in a spread involving 10 long calls, the total debit must
|
||
be 10 points or less. These screens are easily applied, especially with the aid of a com
|
||
puter analysis. One merely uses the deltas to determine the neutral ratio. Then, if it
|
||
is too small or too large, or if it requires the outlay of too large a debit, the spread is
|
||
rejected from consideration. If not, it is a potential candidate for investment.
|
||
FOLLOW-UP ACTION
|
||
Depending on the initial credit or debit of the spread, it may not be necessary to take
|
||
any downside defensive action at all. If the initial debit was large, the writer may roll
|
||
down the written calls as in a ratio write.
|
||
Example: An investor has established the ratio write by buying an XYZ July 40 call
|
||
and selling two July 60 calls with the stock near 60. He might have done this because
|
||
the July 40 was selling at parity. If the underlying stock declines, this spreader could
|
||
roll down to the 50's and then to the 45's, in the same manner as he would with a ratio
|
||
write. On the other hand, if the spread was initially set up with contiguous striking
|
||
prices, the lower strike being just below the higher strike, no rolling-down action
|
||
would be necessary. |