35 lines
2.1 KiB
Plaintext
35 lines
2.1 KiB
Plaintext
236 • The Intelligent Option Investor
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Because we must fully margin a short-put investment, that leg of
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the long diagonal carries with it a loss leverage ratio of –1.0. However, the
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OTM call leg represents an immediate realized loss coupled with a very
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high lambda value for gains. As such, if the put option expires ITM, the
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long diagonal is simply a levered strategy; if the put option expires OTM,
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the investment is a very highly levered one because the unlevered put
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ceases to influence the leverage equation. Another short put may be written
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after the previous short put expires; this further subsidizes the cost of the
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calls and so greatly increases the leverage on the strategy.
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If the stock moves quickly toward the upper valuation range, this
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structure becomes extremely profitable on an unrealized basis. If the put
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option expires ITM, the investor is left with a levered long investment in
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the stock in addition to the long position in the OTM. As in any other
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complex structure, the investment may be ratioed—for instance, by buying
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one call for every two puts sold or vice versa.
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Strike Price Selection
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The put should be sold ATM or close to ATM in order to maximize the time
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value sold, as explained earlier in the short-put summary. The call strike may be
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bought at any level depending on the investor’s appetite for leverage but is usu-
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ally purchased OTM. The following table shows the net debit or credit associated
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with the long diagonal between the ATM put ($55 strike price, delta of –0.42,
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priced at the bid price) with an expiration of 79 days and each call strike (at the
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ask price) listed, all of which are long-term equity anticipated securities (LEAPS)
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having expirations in 534 days. The lambda figure for the OTM calls is also given
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to provide an idea of the comparative leverage of each call option. For this exam-
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ple, I am using JP Morgan Chase (JPM) when its stock was trading for $56.25.
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Strike Delta (Debit) Credit Call Lambda (%)
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57.50 0.43 (2.52) 5.6
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60.00 0.37 (1.57) 6.1
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62.50 0.31 (0.76) 6.7
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65.00 0.26 (0.25) 7.0
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70.00 0.16 0.78 8.4
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75.00 0.10 1.28 9.5
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80.00 0.06 1.56 10.5 |