35 lines
2.0 KiB
Plaintext
35 lines
2.0 KiB
Plaintext
776
|
||
FIGURE 37-8.
|
||
Put credit (bull) spread profit in 30 days.
|
||
1000
|
||
500
|
||
- 1000 _ _,±8±
|
||
Assignment Risk Area
|
||
IV=30%
|
||
Stock
|
||
Part VI: Measuring and Trading Volatility
|
||
-~
|
||
IV= 30%
|
||
130 140
|
||
First, one can observe that a bull put spread does not widen out to anywhere
|
||
near its maximum potential if implied volatility increases. The same thing was seen
|
||
with the call bull spread in the previous section. But a put bull spreader is caught in
|
||
another trap: If implied volatility falls and the stock falls too, the risk of early assign
|
||
ment materializes quicky. Note the shaded area at the lower left of the graph, extend
|
||
ing from a price of about 94 on down. After thirty days (so there would be three
|
||
months life remaining at that point in time), if implied volatility is 30%, the 110 put
|
||
(the short put) would be trading at parity for stock prices of 94 and below. Thus, it
|
||
would be at risk of early assignment. If implied volatility were even lower, the puts
|
||
would be at parity for much higher stock prices.
|
||
Now, in and of itself, early assignment on an equity or futures put spread is not
|
||
necessarily a terrible thing. There will be a request for additional margin (because
|
||
the stock has to be paid for or the futures contract margined), but the risk is still the
|
||
same in dollar terms. Of course, the request for extra margin could be backbreaking
|
||
for a stock trader if he can't afford to fully pay for the stock, and the early assignment
|
||
would probably incur additional commission costs, too. However, with cash-based
|
||
index options there is a more serious increase in risk after an early assignment,
|
||
because one is left with only the long side of the spread. If that option happens to
|
||
have substantial value, then there is considerable risk if the underlying should quick
|
||
ly move higher. In fact, by the time one unwinds the spread, he might actually end
|
||
up losing more than his original limited risk amount - all due to the early assignment.
|
||
(This could happen if the underlying first plunges in price, placing both options |