38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
278 Part Ill: Put Option Strategies
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large losses. The covered writer who buys puts may often find it easier to operate in
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a more rational manner when he has the protective put in place.
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This strategy is equivalent to one that has been described before, the bull
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spread. Notice that the profit graph in Figure 17-2 has the same shape as the bull
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spread profit graph (Figure 7-1). This means that the two strategies are equivalent.
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In fact, in Chapter 7 it was pointed out that the bull spread could sometimes be con
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sidered a "substitute" for covered writing. Actually, the bull spread is more akin to
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this strategy - the covered write protected by a put purchase. There are, of course,
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differences between the strategies. They are equivalent in profit and loss potential,
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but the covered writer could never lose all his investment in a short period of time,
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although the spreader could. In order to actually use bull spreads as substitutes for
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covered ,vrites, one would invest only a small portion of his available funds in the
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spread and would place the remainder of his funds in fixed-income securities. That
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strategy was discussed in more depth in Chapter 7.
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NO-COST COLLARS
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The "collar" strategy is often arrived at in another manner: a stockholder begins
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to worry about the downside potential of the stock market and decides to buy puts
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on his stock as protection. However, he is dismayed by the cost of the puts and so he
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also considers the sale of calls. If he buys an out-of-the-money put, it is quite possi
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ble that he might be able to sell an out-of-the-money call whose proceeds complete
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ly cover the cost of the put. Thus, he has established a protective collar at no cost -
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at least no debit. His "cost" is the fact that he has forsaken the upside profit poten
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tial on his stock, above the striking price of the written call.
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In fact, certain large institutional traders are able to transact collars through
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large over-the-counter option brokers, such as Goldman Sachs or Morgan Stanley.
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They might even give the broker instructions such as this: "I own XYZ and I want to
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buy a put 10 percent out of the money that expires in a year. What would the strik
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ing p1ice of a one-year call have to be in order to create a no-cost collar?" The bro
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ker might then tell him that such a call would have to be struck 30 percent out of the
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money. The actual strike price of the call would depend on the volatility estimate for
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the underlying stock, as well as interest rates and dividends. These types of transac
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tions occur with a fair amount of frequency.
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Some very interesting situations can be created with long-term options. One of
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the most interesting occurred in 1999, when a company that owned 5 million shares
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of Cisco ( CSCO) decided it would like to hedge them by creating a no-cost collar
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over the next three years. At the time, CSCO was trading at about 130, and its volatil
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ity was about 50%. It turns out that a three-year put struck at 130 sells for about the |