35 lines
2.1 KiB
Plaintext
35 lines
2.1 KiB
Plaintext
is found by subtracting the premium paid, 2.30, from the strike price, 139.
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This is the point at which the position breaks even. If SPY is below $136.70
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at expiration, Isabel has a profit. Profits will increase on a tick-for-tick
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basis, with downward movements in SPY down to zero. The long put has
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limited risk and substantial reward potential.
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An alternative for Isabel is to short the ETF at the current price of
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$140.35. But a short position in the underlying may not be as attractive to
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her as a long put. The margin requirements for short stock are significantly
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higher than for a long put. Put buyers must post only the premium of the put
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—that is the most that can be lost, after all.
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The margin requirement for short stock reflects unlimited loss potential.
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Margin requirements aside, risk is a very real consideration for a trader
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deciding between shorting stock and buying a put. If the trader expects high
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volatility, he or she may be more inclined to limit upside risk while
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leveraging downside profit potential by buying a put. In general, traders buy
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options when they expect volatility to increase and sell them when they
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expect volatility to decrease. This will be a common theme throughout this
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book.
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Consider a protective put example:
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This is an example of a situation in which volatility is expected to
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increase.
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Own 100 shares SPY at 140.35
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Buy 1 SPY May139 put at 2.30
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Although Isabel bought a put because she was bearish on the Spiders, a
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different trader, Kathleen, may buy a put for a different reason—she’s
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bullish but concerned about increasing volatility. In this example, Kathleen
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has owned 100 shares of Spiders for some time. SPY is currently at
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$140.35. She is bullish on the market but has concerns about volatility over
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the next two or three months. She wants to protect her investment. Kathleen
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buys 1 SPY May 139 put at 2.30. (If Kathleen bought the shares of SPY and
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the put at the same time, as a spread, the position would be called a married
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put.)
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Kathleen is buying the right to sell the shares she owns at $139.
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Effectively, it is an insurance policy on this asset. Exhibit 1.7 shows the risk
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profile of this new position. |