38 lines
2.5 KiB
Plaintext
38 lines
2.5 KiB
Plaintext
Chapter 34: Futures and Futures Options 691
|
||
ridiculously far out-of-the-money options, as one is wasting his theoretical advantage
|
||
if the futures do not have a realistic chance to climb to the striking price of the writ
|
||
ten options. Finally, do not attempt to use overly large ratios in order to gain the most
|
||
theoretical advantage. This is an important concept, and the next example illustrates
|
||
it well.
|
||
Example: Assume the same pricing pattern for January soybean options that has
|
||
been the basis for this discussion. January beans are trading at 583. The (novice)
|
||
strategist sees that the slightly in-the-money January 575 call is the cheapest and the
|
||
deeply out-of-the-money January 675 call is the most expensive. This can be verified
|
||
from either of two previous tables: the one showing the actual price as compared to
|
||
the "theoretical" price, or Table 34-2 showing the implied volatilities.
|
||
Again, one would use the deltas (see Table 34-2) to create a neutral spread. A
|
||
neutral ratio of these two would involve selling approximately six calls for each one
|
||
purchased.
|
||
Buy 1 January bean 575 call at 191/z
|
||
Sell 6 January bean 675 calls at 21/4
|
||
Net position:
|
||
191/z DB
|
||
131/z CR
|
||
6 Debit
|
||
Figure 34-3 shows the possible detrimental effects of using this large ratio.
|
||
While one could make 94 points of profit if beans were at 675 at January expiration,
|
||
he could lose that profit quickly if beans shot on through the upside break-even
|
||
point, which is only 693.8. The previous formulae can be used to verify these maxi
|
||
mum profit and upside break-even point calculations. The upside break-even point
|
||
is too close to the striking price to allow for reasonable follow-up action. Therefore,
|
||
this would not be an attractive position from a practical viewpoint, even though at
|
||
first glance it looks attractive theoretically.
|
||
It would seem that neutral spreading could get one into trouble if it "recom
|
||
mends" positions like the 6-to-l ratio spread. In reality, it is the strategist who is get
|
||
ting into trouble if he doesn't look at the whole picture. The statistics are just an aid
|
||
- a tool. The strategist must use the tools to his advantage. It should be pointed out
|
||
as well that there is a tool missing from the toolkit at this point. There are statistics
|
||
that will clearly show the risk of this type of high-rati<,Yspread. In this case, that tool
|
||
is the gamma of the option. Chapter 40 covers the -Lise of gamma and other more
|
||
advanced statistical tools. This same example is expanded in that chapter to include
|
||
the gamma concept. |