38 lines
2.3 KiB
Plaintext
38 lines
2.3 KiB
Plaintext
Chapter 3: Call Buying 105
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Suppose the volatile stock in our example, WS, has the potential to rise by 12%
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in 90 days, while the less volatile stock, NVS, has the potential of rising only 4% in 90
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days. In 90 days, the July 40 calls will not be at parity, because there will be some time
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remaining until July expiration. Thus, it is necessary to attempt to predict what their
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prices will be at the end of the 90-day holding period. Assume that the following
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prices are accurate estimates of what the July 40 calls will be selling for in 90 days, if
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the underlying stocks advance in relation to their volatilities:
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Stock Price in 90 Days
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VVS: 44.8 (up 12%)
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NVS: 41 .6 (up 4%)
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Coll Price
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VVS July 40: 6 (up 50%)
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NVS July 40: 21/2 (up 25%)
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With some time remaining in the calls, they would both have time value premium at
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the end of 90 days. The bigger time premium would be in the WS call, since the
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underlying stock is more volatile. Under this method of analysis, the WS call is still
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the better one to buy.
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The correct method of ranking potential reward situations for call buyers is as
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follows:
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1. Assume each underlying stock can advance in accordance with its volatility over
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a fixed period (30, 60, or 90 days).
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2. Estimate the call prices after the advance.
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3. Rank all potential call purchases by highest percentage reward opportunity for
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aggressive purchases.
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4. Assume each stock can decline in accordance with its volatility.
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5. Estimate the call prices after the decline.
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6. Rank all purchases by reward/risk ratio ( the percentage gain from item 2 divided
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by the percentage loss from item 5).
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The list from item 3 will generate more aggressive purchases because it incorporates
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potential rewards only. The list from item 6 would be a less speculative one. This
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method of analysis automatically incorporates the criteria set forth earlier, such as
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buying short-term out-of-the-money calls for aggressive purchases and buying
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longer-term in-the-money calls for a more conservative purchase. The delta is also a
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function of the volatility and is essentially incorporated by steps 1 and 4.
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It is virtually impossible to perform this sort of analysis without a computer. The
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call buyer can generally obtain such a list from a brokerage firm or from a data serv
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ice. For those individuals who have access to a computer and would like to generate |