37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
308 Part Ill: Put Option Strategies
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form of an expected return analysis, will be presented in Chapter 28 on mathemati
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cal applications.
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More screens can be added to produce a more conservative list of straddl<'
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writes. For example, one might want to ignore any straddles that are not worth at
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least a fixed percentage, say 10%, of the underlying stock price. Also, straddles that
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are too short-term, such as ones with less than 30 days of life remaining, might b<'
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thrown out as well. The remaining list of straddle writing candidates should be ones
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that will provide reasonable returns under favorable conditions, and also should be
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readily adaptable to some of the follow-up strategies discussed later. Finally, one
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would generally like to have some amount of technical support at or above the lower
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break-even price and some technical resistance at or below the upper break-even
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point. Thus, once the computer has generated a list of straddles ranked by an index
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such as the one listed above, the straddle writer can further pare down the list by
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looking at the technical pictures of the underlying stocks.
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FOLLOW-UP ACTION
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The risks involved in straddle writing can be quite large. When market conditions are
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favorable, one can make considerable profits, even with restrictive selection require
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ments, and even by allowing considerable extra collateral for adverse stock move
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ments. However, in an extremely volatile market, especially a bullish one, losses can
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occur rapidly and follow-up action must be taken. Since the time premium of a put
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tends to shrink when it goes into-the-money, there is actually slightly less risk to the
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downside than there is to the upside. In an extremely bullish market, the time value
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premiums of call options will not shrink much at all and might even expand. This may
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force the straddle writer to pay excessive amounts of time value premium to buy back
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the written straddle, especially if the movement occurs well in advance of expiration.
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The simplest form of follow-up action is to buy the straddle back when and if the
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underlying stock reaches a break-even point. The idea behind doing so is to limit the
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losses to a small amount, because the straddle should be selling for only slightly more
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than its original value when the stock has reached a break-even point. In practice,
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there are several flaws in this theory. If the underlying stock arrives at a break-even
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point well in advance of expiration, the amount of time value premium remaining in
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the straddle may be extremely large and the writer will be losing a fairly large amount
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by repurchasing the straddle. Thus, a break-even point at expiration is probably a loss
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point prior to expiration.
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Example: After the straddle is established with the stock at 45, there is a sudden rally
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in the stock and it climbs quickly to 52. The call might be selling for 9 points, even |