50 lines
2.6 KiB
Plaintext
50 lines
2.6 KiB
Plaintext
338
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TABLE 23-1.
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Butterfly spread.
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Bull Spread
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(Buy Option at 50, ... plus ...
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Sell at 60)
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Calls (6 debit)
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Calls (6 debit)
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Puts (4 credit)
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Puts (4 credit)
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Bear Spread
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(Buy Option at 70,
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Sell at 60)
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Calls (4 credit)
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Puts (6 debit)
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Calls (4 credit)
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Puts (6 debit)
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Part Ill: Put Option Strategies
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Total Money
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2 debit
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12 debit
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8 credit
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2 debit
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The factor that causes all these combinations to be equal in risk and reward is
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the arbitrageur. If put and call prices get too far out of line, the arbitrageur can take
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riskless action to force them back. This particular form of arbitrage, known as the box
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spread, is described later, in Chapter 27, Arbitrage.
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Even though all four ways of constructing the butterfly spread are equal at
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expiration, some are superior to others for certain price movements prior to expira
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tion. Recall that it was previously stated that bull spreads are best constructed with
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calls, and bear spreads are best constructed with puts. Since the butterfly spread is
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merely the combination of a bull spread and a bear spread, the best way to set up the
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butterfly spread is to use calls for the bull spread and puts for the bear spread. This
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combination is the one listed on the second line of Table 23-1. This strategy involves
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the largest debit of the four combinations and, as a result, many investors shun this
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approach. However, all the other combinations involve selling an in-the-money put
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or call at the outset, a situation that could lead to early exercise. The reader may also
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recall that the credit combination, listed on the third line of Table 23-1, was previ
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ously described as a protected straddle position. That is, one sells a straddle and
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simultaneously buys both an out-of-the-money put and an out-of-the-money call with
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the same expiration month, as protection for the straddle. Thus, a butterfly spread is
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actually the equivalent of a completely protected straddle wiite.
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A butterfly spread is not an overly attractive strategy, although it may be useful
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from time to time. The commissions required are extremely high, and there is no
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chance of making a large profit on the position. The limited risk feature is good to
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have in a position, but it alone cannot compensate for the less attractive features of
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the strategy. Essentially, the strategist is looking for the stock to remain in a neutral
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pattern until the options expire. If the potential profit is at least three times the max
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imum 1isk (and preferably four times) and the underlying stock appears to be in trad
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ing range, the strategy is feasible. Othe:nvise, it is not. |