36 lines
2.7 KiB
Plaintext
36 lines
2.7 KiB
Plaintext
Chapter 6: Ratio Call Writing 155
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underpriced, the advantage lies with the buyer of calls, and that situation is inherent
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in the reverse hedge strategy.
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The summaries stated in the above paragraph are rather simplistic ones, refer
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ring mostly to what one can expect from the strategies if they are held until expira
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tion, without adjustment. In actual trading situations, it is much more likely that one
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would have to make adjustments to the ratio write along the way, thus disturbing or
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perhaps even eliminating the profit range. Such travails do not befall the reverse
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hedge (simulated straddle buy). Consequently, when one takes into consideration the
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stock movements that can take place prior to expiration, the ratio write loses some of
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its attractiveness and the reverse hedge gains some.
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THE VARIABLE RATIO WRITE
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In ratio writing, one generally likes to establish the position when the stock is trading
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relatively close to the striking price of the written calls. However, it is sometimes the
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case that the stock is nearly exactly between two striking prices and neither the in
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the-money nor the out-of-the-money call offers a neutral profit range. If this is the
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case, and one still wants to be in a 2:1 ratio of calls written to stock owned, he can
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sometimes write one in-the-money call and one out-of-the-money call against each
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100 shares of common. This strategy, often termed a variable ratio write or trape
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zoidal hedge, serves to establish a more neutral profit range.
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Example: Given the following prices: XYZ common, 65; XYZ October 60 call, 8; and
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XYZ October 70 call, 3.
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If one were to establish a 2:1 ratio write with only the October 60's, he would
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have a somewhat bearish position. His profit range would be 49 to 71 at expiration.
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Since the stock is already at 65, this means that he would be allowing room for 16
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points of downside movement and only 6 points on the upside. This is certainly not
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neutral. On the other hand, if he were to attempt to utilize only the October 70 calls
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in his ratio write, he would have a bullish position. This profit range for the October
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70 ratio write would be 59 to 81 at expiration. In this case, the stock at 65 is too close
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to the downside break-even point in comparison to its distance from the upside
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break-even point.
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A more neutral position can be established by buying 100 XYZ and selling one
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October 60 and one October 70. This position has a profit range that is centered
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about the current stock price. Moreover, the new position has both an upside and a
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downside risk, as does a more normal ratio write. However, now the maximum prof
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it can be obtained anywhere between the two strikes at expiration. To see this, note |