38 lines
2.7 KiB
Plaintext
38 lines
2.7 KiB
Plaintext
114 Part II: Call Option Strategies
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spread strategy, however, would result in a total loss of $300 only if XYZ were below
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30 at October expiration. With XYZ above 30 in October, the long side of the spread
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could be liquidated for some value, thereby avoiding a total loss. The investor has
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reduced the chance of realizing the maximum loss, since the stock price at which that
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loss would occur has been lowered by 5 points.
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As with most investments, the improvement of risk exposure - lowering the
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break-even point and lowering the maximum loss price - necessitates that some
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potential reward be sacrificed. In the original long call position (the October 35), the
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maximum profit potential was unlimited. In the new position, the potential profit is
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limited to 2 points if XYZ should rally back to, or anywhere above, 35 by October
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expiration. To see this, assume XYZ is 35 at expiration. Then the long October 30 call
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would be worth 5 points, while the October 35 would expire worthless. Thus, the
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spread could be liquidated for 5 points, a 2-point profit over the 3 points paid for the
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spread. This is the limit of profit for the spread, however, since if XYZ is above 35 at
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expiration, any further profits in the long October 30 call would be offset by a corre
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sponding loss on the short October 35 call. Thus, if XYZ were to rally heavily by expi
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ration, the "rolled down" position would not realize as large a profit as the original
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long call position would have realized.
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Table 3-5 and Figure 3-2 summarize the original and new positions. Note that
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the new position is better for stock prices between 30 and 40. Below 30, the two posi
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tions are equal, except for the additional commissions spent. If the stock should rally
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back above 40, the original position would have worked out better. The new position
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is an improvement, provided that XYZ does not rally back above 40 by expiration.
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The chances that XYZ could rally 8 points, or 25%, from 32 to 40 would have to be
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considered relatively remote. Rolling the long call down into the spread would thus
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appear to be the correct thing to do in this case.
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This example is particularly attractive, because no additional money was
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required to establish the spread. In many cases, however, one may find that the long
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call cannot be rolled into the spread at even money. Some debit may be required.
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This fact should not necessarily preclude making the change, since a small addition
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al investment may still significantly increase the chance of breaking even or making
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a profit on a rebound.
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Example: The following prices now exist, rather than the ones used earlier. Only the
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October 30 call price has been altered:
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XYZ, 32;
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XYZ October 35 call, 1 ½; and
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XYZ October 30 call, 4. |