38 lines
2.6 KiB
Plaintext
38 lines
2.6 KiB
Plaintext
Chapter 40: Advanced Concepts 869
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in price by 0.55; so seven of them will increase by 7 x 0.55, or 3.85 points total.
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Similarly, the January 55 will increase in price by 0.35, so eleven of them would
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increase in price by 11 x 0.35, or 3.85 points total. Hence, the long side of the spread
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would profit by 3.85 points, while the short side loses 3.85 points - a neutral situation.
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The resulting position is a ratio spread. The profitability of the spread occurs
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between about 51 and 62 at expiration as shown in Figure 40-8, but that is not the
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major point. The real attractiveness of the spread to the neutral trader is that if the
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underpriced nature of the January 50 call (vis-a-vis the January 55 call) should dis
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appear, the spread should produce a profit, regardless of the short-term market
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movement of XYZ. The spread could then be closed if this should occur.
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To illustrate this fact, suppose that XYZ actually falls to 49, but the January 50
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call returns to "fair value":
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XYZ: 49
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"Theoretical
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Option Price Delta Value"
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January 50 call 3.00 0.52 3.00
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January 55 call 1.10 0.34 1.13
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February 50 put 3.90 -0.42 3.84
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Notice that the theoretical values in this table are equal to the theoretical val
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ues from the previous table, less the amount of the delta. Since the XYZ January 50
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call is no longer underpriced, the position would be removed, and the strategist
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would make nothing on his January 50's, but would make .40 on each of the eleven
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short January 55's, for a profit of $440 less commissions.
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This example leans heavily on the assumption that one is able to accurately esti
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mate the theoretical value and delta of the options. In real life, this chore can be
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quite difficult, since the estimate requires one to define the future volatility of the
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common stock. This is not easy. However, for the purposes of a spread, the ratio of
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the two deltas is used. Moreover, the example didn't require that one know the exact
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theoretical value of each option; rather, the only knowledge that was required was
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that one of the options was cheap with respect to the other options.
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As an alternative to a ratio spread, another type of delta neutral position could
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be established from the previous data: Buy the January 50 call (this is the basis of the
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position since it is supposedly the cheap option) and buy the February 50 put - the
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only other choice from the data given. This position is a long straddle of sorts. Recall
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that the delta of a put is negative; so again, the delta neutral ratio can be calculated
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by dividing the absolute value of two deltas:
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Delta neutral straddle ratio= 0.55/1-0.401 = 11-to-8 |