44 lines
1.9 KiB
Plaintext
44 lines
1.9 KiB
Plaintext
Chapter 11: Ratio Call Spreads 215
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These two philosophies are not mutually exclusive. The strategist who uses ratio
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spreads without regard for whether they are debit or credit spreads will generally
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have a broader array of spreads to choose from and will also be able to assume a more
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neutral posture on the stock. The spreader who insists on generating credits only will
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be forced to establish spreads on which his return will be slightly smaller if the under
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lying stock remains relatively unchanged. However, he will not have to worry about
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downside defensive action, since he has no risk to the downside. The third philoso
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phy, the "delta spread," is described after the next section, in which the uses of ratios
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other than 2: 1 are described.
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ALTERING THE RATIO
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Under either of the two philosophies discussed above, the strategist may find that a
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3:1 ratio or a 3:2 ratio better suits his purposes than the 2:1 ratio. It is not common
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to write in a ratio of greater than 4: 1 because of the large increase in upside risk at
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such high ratios. The higher the ratio that is used, the higher will be the credits of
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the spread. This means that the profits to the downside will be greater if the stock
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collapses. The lower the ratio that is used, the higher the upside break-even point will
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be, thereby reducing upside risk.
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Example: If the same prices are used as in the initial example in this chapter, it will
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be possible to demonstrate these facts using three different ratios (Table 11-3):
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XYZ common, 44;
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XYZ April 40 call, 5; and
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XYZ April 45 call, 3.
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TABLE 11-3.
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Comparison of three ratios.
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Price of spread
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(downside risk)
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Upside break-even
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Downside break-even
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Maximum profit
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3:2 Ratio:
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Buy 2 April 40's
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Sell 3 April 45's
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1 debit
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54
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401/2
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9
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2:1 Ratio: 3:1 Ratio:
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By 1 April 40 Buy 1 April 40
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Sell 2 April 45's Sell 3 April 45's
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1 credit 4 credit
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51 49½
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None None
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6 9 |