36 lines
2.7 KiB
Plaintext
36 lines
2.7 KiB
Plaintext
194 Part II: Call Option Strategies
|
||
above 60 for the maximum loss to occur. Even if the stock is at 40 or 60, there is some
|
||
time premium left in the longer-term option, and the loss is not quite as large as the
|
||
maximum possible loss of $300.
|
||
This type of calendar spread has limited profits and relatively large commission
|
||
costs. It is generally best to establish such a spread 8 to 12 weeks before the near
|
||
term option expires. If this is done, one is capitalizing on the maximum rate of decay
|
||
of the near-term option with respect to the longer-term option. That is, when a call
|
||
has less than 8 weeks of life, the rate of decay of its time value premium increases
|
||
substantially with respect to the longer-term options on the same stock.
|
||
THE EFFECT OF VOLATILITY
|
||
The implied volatility of the options (and hence the actual volatility of the underly
|
||
ing stock) will have an effect on the calendar spread. As volatility increases, the
|
||
spread widens; as volatility contracts, the spread shrinks. This is important to know.
|
||
In effect, buying a calendar spread is an antivolatility strategy: One wants the under
|
||
lying to remain somewhat unchanged. Sometimes, calendar spreads look especially
|
||
attractive when the underlying stock is volatile. However, this can be misleading for
|
||
two reasons. First of all, since the stock is volatile, there is a greater chance that it will
|
||
move outside of the profit area. Second, if the stock does stabilize and trades in a
|
||
range near the striking price, the spread will lose value because of the decrease in
|
||
volatility. That loss may be greater than the gain from time decay!
|
||
FOLLOW-UP ACTION
|
||
Ideally, the spreader would like to have the stock be just below the striking price
|
||
when the near-term call expires. If this happens, he can close the spread with only
|
||
one commission cost, that of selling out the long call. If the calls are in-the-money at
|
||
the expiration date, he will, of course, have to pay two commissions to close the
|
||
spread. As with all spread positions, the order to close the spread should be placed
|
||
as a single order. "Legging" out of a spread is highly risky and is not recommended.
|
||
Prior to expiration, the spreader should close the spread if the near-term short
|
||
call is trading at parity. He does this to avoid assignment. Being called out of spread
|
||
position is devastating from the viewpoint of the stock commissions involved for the
|
||
public customer. The near-term call would not normally be trading at parity until
|
||
quite close to the last day of trading, unless the stock has undergone a substantial rise
|
||
in price.
|
||
In the case of an early downside breakout by the underlying stock, the spread
|
||
er has several choices. He could immediately close the spread and take a small loss |