39 lines
3.1 KiB
Plaintext
39 lines
3.1 KiB
Plaintext
Chapter 23: Spreads Combining Calls and Puts 349
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40 straddle. However, he has now invested a total of 5 points in the position: the orig
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inal 2-point debit plus the 3 points that he paid to buy back the January 40 straddle.
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Hence, his risk has increased to 5 points. If XYZ were to be at exactly 40 at April expi
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ration, he would lose the entire 5 points. While the probability of losing the entire 5
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points must be considered small, there is a substantial chance that he might lose
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more than 2 points his original debit. Thus, he has increased his risk by buying back
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the near-term straddle and continuing to hold the longer-term one.
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This is actually a neutral strategy. Recall that when calendar spreads were dis
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cussed previously, it was pointed out that one establishes a neutral calendar spread
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with the stock near the striking price. This is true for either a call calendar spread or
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a put calendar spread. This strategy - a calendar spread with straddles is merely the
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combination of a neutral call calendar spread and a neutral put calendar spread.
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Moreover, recall that the neutral calendar spreader generally establishes the position
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with the intention of closing it out once the near-term option expires. He is mainly
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interested in selling time in an attempt to capitalize on the fact that a near-term
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option loses time value premium more rapidly than a longer-term option does. The
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straddle calendar spread should be treated in the same manner. It is generally best
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to close it out at near-term expiration. If the stock is near the striking price at that
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time, a profit will generally result. To verify this, refer again to the prices in the pre
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ceding paragraph, with XYZ at 43 at January expiration. The January 40 straddle can
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be bought back for 3 points and the April 40 straddle can be sold for 6. Thus, the dif
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ferential between the two straddles has widened to 3 points. Since the original dif
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ferential was 2 points, this represents a profit to the strategist.
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The maximum profit would be realized if XYZ were exactly at the striking price
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at near-term expiration. In this case, the January 40 straddle could be bought back
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for a very small fraction and the April 40 straddle might be worth about 5 points. The
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differential would have widened from the original 2 points to nearly 5 points in this
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case.
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This strategy is inferior to the one described in the previous section (the "calen
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dar combination"). In order to have a chance for unlimited profits, the investor must
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increase his net debit by the cost of buying back the near-term straddle.
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Consequently, this strategy should be used only in cases when the near-term straddle
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appears to be extremely overpriced. Furthermore, the position should be closed at
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near-term expiration unless the stock is so close to the striking price at that time that
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the near-term straddle can be bought back for a fractional price. This fractional buy
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back would then give the strategist the opportunity to make large potential profits
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with only a small increase in his risk. This situation of being able to buy back the near
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term straddle at a fractional price will occur very infrequently, much more infre- |