35 lines
2.1 KiB
Plaintext
35 lines
2.1 KiB
Plaintext
O,apter 31: Index Spreading 585
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still make money, even if he was wrong in his prediction of the relationship of the
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cash indices.
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Example: The following prices exist:
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ZYX: 175.00
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UVX: 150.00
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ZYX Dec 185 put: 10½
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UVX Dec 140 call: 11
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Suppose that one wants to buy the UVX index and sell the ZYX index. He
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expects the spread between the two - currently at 25 points - to narrow. He could
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buy the UVX futures and sell the ZYX futures. However, suppose that instead he buys
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the ZYX put and buys the UVX call.
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The time value of the Dec 185 put is 1/2 point and that of the Dec 140 call is 1
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point. This is a relatively small amount of time value premium. Therefore, the com
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bination would have results very nearly the same as the futures spread, as long as
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both options remain in-the-money; the only difference would be that the futures
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spread would outperform by the amount of the time premium paid.
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Even though he pays some time value premium for this long option combina
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tion, the investor has the opportunity to make larger profits than he would with the
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futures spread. In fact, he could even make a profit if the cash spread widens, if the
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indices are volatile. To see this, suppose that after a large upward move by the over
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all market, the following prices exist:
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ZYX: 200.00
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UVX: 170.00
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ZYX Dec 185 put: 0 ( virtually worthless)
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UVX Dec 140 call: 30
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The combination that was originally purchased for 21 ½ points is now worth 30,
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so the spread has made money. But observe what has happened to the cash spread:
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It has widened to 30 points, from the original price of 25. This is a movement in the
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opposite direction from what was desired, yet the option position still made money.
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The reason that the option combination in the example was able to make
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money, even though the cash spread moved unfavorably, is because both indices rose
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so much in price. The puts that were owned eventually became worthless, but the
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long call continued to make money as the market rose. This is a situation that is very
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similar to owning a long strangle (long put and call with different strikes), except that |