24 lines
1.7 KiB
Plaintext
24 lines
1.7 KiB
Plaintext
Put Buying in Conjunction
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with Com.m.on Stock
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Ownership
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Another useful feature of put options, in addition to their speculative leverage in a
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downward move by the underlying stock, is that the put purchase can be used to limit
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downside loss in a stock that is owned. When one simultaneously owns both the com
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mon stock and a put on that same stock, he has a position with limited downside risk
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during the life of the put. This position is also called a synthetic long call, because the
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profit graph is the same shape as a long call's.
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Example: An investor owns XYZ stock, which is at 52, and purchases an XYZ October
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50 put for 2. The put gives him the right to sell XYZ at 50, so the most that the stock
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holder can lose on his stock is 2 points. Since he pays 2 points for the put protection, his
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maximum potential loss until October expiration is 4 points, no matter how far XYZ
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might decline up until that time. If, on the other hand, the price of the stock should
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move up by October, the investor would realize any gain in the stock, less the 2 points
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that he paid for the put protection. The put functions much like an insurance policy with
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a finite life. Table 17-1 and Figure 17-1 depict the results at October expiration for this
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position: buying the October 50 put for 2 points to protect a holding in XYZ common
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stock, which is selling at 52. The dashed line on the graph represents the profit poten
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tial of the common stock ownership by itself. Notice that if the stock were below 48 in
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October, the common stock owner would have been better off buying the put. However,
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with XYZ above 48 at expiration, the put purchase was a burden that cost a small por
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tion of potential profits. This strategy, however, is not necessarily geared to maximizing
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