39 lines
3.0 KiB
Plaintext
39 lines
3.0 KiB
Plaintext
Chapter 25: LEAPS 383
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buyer to less risk of time decay on a daily basis. This is true because the extreme neg
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ative effects of time decay magnify as the option approaches its expiration. Recall that
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it was shown in Chapter 3 that time decay is not linear: An option decays more rap
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idly at the end of its life than at the beginning. Eventually, a LEAPS put or call will
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become a normal short-term equity option and time will begin to take a more rapid
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toll. But in the beginning of the life of LEAPS, there is so much time remaining that
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the short-term decay is not large in terms of price.
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Table 25-2 and Figure 25-4 depict the rate of decay of two options: one is at
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the-money (the lower curve) and the other is 20% out-of-the-money (the upper
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curve). The horizontal axis is months of life remaining until expiration. The vertical
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axis is the percent of the option price that is lost daily due to time decay. The options
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that qualify as LEAPS are ones with more than 9 months oflife remaining, and would
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thus be the ones on the lower right-hand part of the graph.
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The upward-sloping nature of both curves as time to expiration wanes shows
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that time decay increases more rapidly as expiration approaches. Notice how much
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more rapidly the out-of-the-money option decays, percentagewise, than the at-the
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money. LEAPS, however, do not decay much at all compared to normal equity
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options. Most LEAPS, even the out-of-the-money ones, lose less than¼ of one per
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cent of their value daily. This is a pittance when compared with a 6-month equity
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option that is 20% out-of-the-money- that option loses well over 1 % of its value daily
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and it still has 6 months of life remaining.
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From the accompanying table, observe that the out-of-the-money 2-month
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option loses over 4% of its value daily!
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Thus, LEAPS do not decay at a rapid rate. This gives the LEAPS holder a
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chance to have his opinion about the stock price work for him without having to
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worry as much about the passage of time as the average equity option holder would.
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An advantage of owning LEAPS, therefore, is that one's timing of the option pur
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chase does not have to be as exact as that for shorter-term option buying. This can be
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a great psychological advantage as well as a strategic advantage. The LEAPS option
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buyer who feels strongly that the stock will move in the desired direction has the lux
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ury of being able to wait calmly for the anticipated move to take place. If it does not,
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even in perhaps as long as 6 months' time, he may still be able to recoup a reason
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able portion of his initial purchase price because of the slow percentage rate of decay.
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Do not be deluded into believing that LEAPS don't decay at all. Although the
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rate of decay is slow (as shown previously), an option that is losing 0.15% of its value
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daily will still lose about 25% of its value in six months.
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Example: XYZ is at 60 and there are 18-month LEAPS calls selling for $8, with a
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striking price of 60. The daily decay of this call with respect to time will be minus- |