37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
402 Part Ill: Put Option Strategies
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is not the simple discount arbitrage that was discussed in Chapter l when this topic
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was covered. Rather, it is a more complicated form that is discussed in greater detail
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in Chapter 28. Suffice it to say that if the dividend is larger than the interest that can
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be earned from a credit balance equal to the striking price, then the time value pre
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mium will disappear from the call.
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Example: XYZ is a $30 stock and about to go ex-dividend 50 cents. The prevailing
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short-term interest rate is 5% and there are LEAPS with a striking price of 20.
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A 50-cent quarterly dividend on a striking price of 20 is an annual dividend rate
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(on the strike) of 10%. Since short-term rates are much lower than that, arbitrageurs
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economically cannot pay out 10% for dividends and earn 5% for their credit balances.
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In this situation, the LEAPS call would lose its time value premium and would
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be a candidate for early exercise when the stock goes ex-dividend.
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In actual practice, the situation is more complicated than this, because the price
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of the puts comes into play; but this example shows the general reasoning that the
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arbitrageur must go through.
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Certain arbitrageurs construct positions that allow them to earn interest on a
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credit balance equal to the striking price of the call. This position involves being short
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the underlying stock and being long the call. Thus, when the stock goes ex-dividend,
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the arbitrageur will owe the dividend. If, however, the amount of the dividend is
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more than he vvill earn in interest from his credit balance, he will merely exercise his
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call to cover his short stock. This action will prevent him from having to pay out the
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dividend.
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The arbitrageur's exercise of the call means that someone is going to be
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assigned. If you are a writer of the call, it could be you. It is not important to under
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stand the arbitrage completely; its effect will be reflected in the marketplace in the
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form of a call trading at parity or a discount. Thus, even a LEAPS call with a sub
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stantial anwunt of time rernaining may be assigned if it is trading at parity.
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STRADDLE SELLING
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Straddle selling is equivalent to ratio writing and is a strategy whereby one attempts
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to sell ( overpriced) options in order to produce a range of stock prices within which
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the option seller can profit. The strategy often involves follow-up action as the stock
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moves around, and the strategist feels that he must adjust his position in order to pre
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vent large losses. LEAPS puts and calls might be used for this strategy. However,
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their long-term nature is often not conducive to the aims of straddle selling.
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First, consider the effect of time decay. One might normally sell a three-month
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straddle. If the stock "behaves" and is relatively unchanged after two months have |