27 lines
2.0 KiB
Plaintext
27 lines
2.0 KiB
Plaintext
CH.APTER 14
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Diagonalizing a Spread
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When one uses both different striking prices and different expiration dates in a
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spread, it is a diagonal spread. Generally, the long side of the spread would expire
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later than the short side of the spread. Note that this is within the definition of a
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spread for margin purposes: The long side must have a maturity equal to or longer
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than the maturity of the short side. With the exception of calendar spreads, all the
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previous chapters on spreads have described ones in which the expiration dates of the
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short call and the long call were the same. However, any of these spreads can be diag
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onalized; one can replace the long call in any spread with one expiring at a later date.
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In general, diagonalizing a spread in this manner makes it slightly rrwre bear
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ish at near-term expiration. This can be seen by observing what would happen if the
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stock fell or rose substantially. If the stock falls, the long side of the spread will retain
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some value because of its longer maturity. Thus, a diagonal spread will generally do
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better to the downside than will a regular spread. If the stock rises substantially, all
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calls will come to parity. Thus, there is no advantage in the long-term call; it will be
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selling for approximately the same price as the purchased call in a normal spread.
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However, since the strategist had to pay more originally for the longer-term call, his
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upside profits would not be as great.
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A diagonalized position has an advantage in that one can reestablish the posi
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tion if the written calls expire worthless in the spread. Thus, the increased cost of
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buying a longer-term call initially may prove to be a savings if one can write against
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it twice. These tactics are described for various spread strategies.
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THE DIAGONAL BULL SPREAD
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A vertical call bull spread consists of buying a call at a lower striking price and sell
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ing a call at a higher striking price, both with the same expiration date. The diagonal
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