33 lines
2.0 KiB
Plaintext
33 lines
2.0 KiB
Plaintext
20 Part I: Basic Properties ol Stoclc Options
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1. Buy the January 40 call at 9.80.
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2. Sell short XYZ common stock at 50.
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3. Exercise the call to buy XYZ at 40.
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The arbitrageur makes 10 points from the short sale of XYZ (steps 2 and 3), from
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which he deducts the 9.80 points he paid for the call. Thus, his total gain is 20 cents
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- the amount of the discount. Since he pays only a minimal commission, this trans-
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action results in a net profit. '
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Also, if the writer can expect assignment when the option has no time value pre
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mium left in it, then conversely the option will usually not be called if time premium
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is left in it.
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Example: Prior to the expiration date, XYZ is trading at 50½, and the January 50 call
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is trading at 1. The call is not necessarily in imminent danger of being called, since it
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still has half a point of time premium left.
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Time value Call Striking Stock
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= + premium price price price
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= 1 + 50 50½
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= ½
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Early Exercise Due to Dividends on the Underlying Stock. Some
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times the market conditions create a discount situation, and sometimes a large
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dividend gives rise to a discount. Since the stock price is almost invariably
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reduced by the amount of the dividend, the option price is also most likely
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reduced after the ex-dividend. Since the holder of a listed option does not receive
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the dividend, he may decide to sell the option in the secondary market before the
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ex-date in anticipation of the drop in price. If enough calls are sold because of
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the impending ex-dividend reduction, the option may come to parity or even to a
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discount. Once again, the arbitrageurs may move in to take advantage of the sit
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uation by buying these calls and exercising them.
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If assigned prior to the ex-date, the writer does not receive the dividend for he
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no longer owns the stock on the ex-date. Furthermore, if he receives an assignment
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notice on the ex-date, he must deliver the stock with the dividend. It is therefore very
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important for the writer to watch for discount situations on the day prior to the ex
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date. |