38 lines
2.7 KiB
Plaintext
38 lines
2.7 KiB
Plaintext
Cl,apter 18: Buying Puts in Conjunction with Call Purchases
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XYZ common, 45:
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XYZ January 40 call, 7;
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XYZ January 40 put, l; and
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XYZ January 45 put, 3.
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287
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The straddle itself is now worth 8 points. The January 45 put price is included
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because it will be part of one of the follow-up strategies. What could the straddle
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buyer do at this time? First, he might do nothing, preferring to let the straddle run
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its course, at least for three months or so. Assuming that he is not content to sit tight,
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however, he might sell the call, taking his profit, and hope for the stock to then drop
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in price. This is an inferior course of action, since he would be cutting off potential
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large profits to the upside.
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In the older, over-the-counter option market, one might have tried a technique
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known as trading against the straddle. Since there was no secondary market for
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over-the-counter options, straddle buyers often traded the stock itself against the
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straddle that they owned. This type of follow-up action dictated that, if the stock
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rose enough to make the straddle profitable to the upside, one would sell short the
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underlying stock. This involved no extra risk, since if the stock continued up, the
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straddle holder could always exercise his call to cover the short sale for a profit.
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Conversely, if the underlying stock fell at the outset, making the straddle profitable
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to the downside, one would buy the underlying stock. Again, this involved no extra
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risk if the stock continued down, since the put could always be exercised to sell the
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stock at a profit. The idea was to be able to capitalize on large stock price reversals
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with the addition of the stock position to the straddle. This strategy worked best for
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the brokers, who made numerous commissions as the trader tried to gauge the
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whipsaws in the market. In the listed options market, the same strategic effect can
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be realized ( without as large a commission expense) by merely selling out the long
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call on an upward move, and using part of the proceeds to buy a second put similar
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to the one already held. On a downside move, one could sell out the long put for a
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profit and buy a second call similar to the one he already owns. In the example
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above, the call would be sold for 7 points and a second January 40 put purchased for
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1 point. This would allow the straddle buyer to recover his initial 6-point cost and
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would allow for large downside profit potential. This strategy is not recommended,
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however, since the straddle buyer is limiting his profit in the direction that the stock
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is moving. Once the stock has moved from 40 to 45, as in this example, it would be
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more reasonable to expect that it could continue up rather than experience a drop
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of more than 5 points. |