37 lines
2.9 KiB
Plaintext
37 lines
2.9 KiB
Plaintext
480 Part IV: Additional Considerations
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One method of determination involves estimating the liquidating value of the spread
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at successive stock prices. When the liquidating value is found to be equal to the ini
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tial value, plus commissions, a break-even point has been located.
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Example: If the spread in question is using options with a striking price of 30, one
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would begin his break-even point calculations at a price of 30. Estimate the liquidat
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ing value of the spread at 30, 297/s, 29¾, 29-5/s, and so forth until the break-even point
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is found. Once the downside break-even point has been determined in this manner,
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the iterations to locate the upside break-even point should begin again at the striking
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price. Thus, one would evaluate the liquidating value at 30, 301/s, 30¼, and so on. This
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is somewhat of a brute-force method, but with a computer it is fairly fast. The num
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ber of calculations can be reduced by adopting a more complicated iteration process.
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A final useful piece of information can be obtained with the aid of the pricing
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model - the theoretical value of the spread. Recompute the estimated value of both
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the near-term and longer-term calls at the current time and stock price, using the
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implied volatility for the underlying stock. The resultant differential between the two
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estimated call prices may differ substantially from the actual differential, perhaps
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highlighting an attractive calendar spread situation. One would want to establish
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spreads in which the theoretical differential is greater than the actual differential
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(that is, he would want to buy a "cheap" calendar spread).
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Once these pieces of information have been computed, the strategist can rank
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the spread possibilities by whatever criterion he finds most workable. The logical
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method of ranking the spreads is by their return if unchanged. The spreads with the
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highest return if unchanged at near-term expiration are those in which the stock price
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and striking price were close together initially, a basic requirement of the neutral cal
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endar spread. More complicated ranking systems should tty to include the theoreti
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cal value of the spread and possibly even the maximum potential of the spread. A
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similar analysis can, of course, be worked out for put calendar spreads, using the
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arbitrage pricing model for puts.
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RATIO STRATEGIES
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Ratio strategies involve selling naked options. Therefore, the strategist has potential
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ly large risk, either to the upside or to the downside or both. He should attempt to
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get a feeling for how probable this risk is. The formulae for determining the proba
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bility of a stock being above or below a certain price at some time in the future can
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give him these probabilities. For example, in a straddle writing situation, the strate
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gist would want to compute such arithmetic quantities as maximum profit potential,
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return if unchanged, collateral required at upside break-even point or at upside |