39 lines
3.1 KiB
Plaintext
39 lines
3.1 KiB
Plaintext
502 Part V: Index Options and Futures
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options have the European exercise feature. All stock options and some index options
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have the American exercise feature.
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The European exercise feature was introduced because institutional investors
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who might tend to write calls against their portfolio of stocks wanted some assurance
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that their protection wouldn't be unexpectedly taken away from them. Thus several
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index option series became European exercise. Two major ones are the cash-based
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index options on the S&P 500 Index (SPX) and the cash-based options on the Dow
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Jones 30 Industrials. OEX remains an American exercise.
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In-the-money European put options will be cheaper than their American coun
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terparts. This is because an arbitrageur would have to carry the position all the way
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to expiration; he could not exercise his puts and liquidate the position immediately.
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In fact, deeply in-the-money European puts will trade at a discount; the higher short
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term interest rates are, the deeper the discount will be.
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This can affect the full protective capability of long-term European puts. If a
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portfolio manager buys puts to protect his portfolio and the market crashes, the puts
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might be deeply in the money. If these puts have a European exercise feature, they
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would be selling at a deep discount and therefore would not have afforded all the
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price protection that the portfolio manager had been looking for.
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American Exercise Consideration. The primary reason for the holder of an
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index option to exercise the option is to take his profit. One might think that, if the
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holder wanted to take a profit, he would merely sell his option in the open market.
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Of course, if he could, he would. However, many times the deeply in-the-money
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options sell at a substantial discount during the trading day. A deep discount is con
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sidered to be 1/2 to 3/4 of a point, or more. Near the end of the day, these options
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tend to trade at only slight discounts. In either case, the holder of the option may
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decide to exercise rather than to sell at any discount. Of course, if one is the holder
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of a call option that is trading at a substantial discount in the morning of a particular
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day, and he decides to exercise, he may lose more by the end of the day (if the mar
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ket trades down) than he would have if he had merely sold at the deep discount in
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the first place. In fact, some theoreticians feel that the "job" of a deeply in-the-money
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cash-based option during the trading day is to try to predict the market's close. This,
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of course, is not a "job" that can be consistently done with accuracy (if it could, the
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traders doing the predicting would be rich beyond their wildest dreams).
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If the holder of a cash-based call option turned bearish, that would be another
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reason to exercise. That's right - if the holder of a cash-based call option is bearish,
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he should exercise because, by so doing, he liquidates his bullish position and takes
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his profit. This is somewhat opposite from an option that has a physical underlying
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security, such as a stock option. This presents an interesting scenario: If one turns |