35 lines
2.7 KiB
Plaintext
35 lines
2.7 KiB
Plaintext
Chapter 9: Calendar Spreads 197
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reduced to ¼ point. Thus, there is the potential for large profits in bullish calendar
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spreads if the underlying stock rallies above the striking price before the longer-term
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call expires, provided that the short-term call has already expired worthless.
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What chance does the investor have that both ideal conditions will occur? There
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is a reasonably good chance that the written call will expire worthless, since it is a
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short-term call and the stock is below the striking price to start with. If the stock falls,
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or even rises a little - up to, but not above, the striking price the first condition will
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have been met. It is the second condition, a rally above the striking price by the
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underlying stock before the longer-term expiration date, that normally presents the
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biggest problem. The chances of this happening are usually small, but the rewards
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can be large when it does happen. Thus, this strategy offers a small probability of
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making a large profit. In fact, one large profit can easily offset several losses, because
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the losses are small, dollarwise. Even if the stock remains depressed and the July 50
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call in the example expires worthless, the loss is limited to the initial debit of¼ point.
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Of course, this loss represents 100% of the initial investment, so one cannot put all
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his money into bullish calendar spreads.
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This strategy is a reasonable way to speculate, provided that the spreader
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adheres to the following criteria when establishing the spread:
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1. Select underlying stocks that are volatile enough to move above the striking price
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within the allotted time. Bullish calendar spreads may appear to be very "cheap"
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on nonvolatile stocks that are well below the striking price. But if a large stock
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move, say 20%, is required in only a few months, the spread is not worthwhile for
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a nonvolatile stock.
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2. Do not use options more than one striking price above the current market. For
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example, if XYZ were 26, use the 30 strike, not the 35 strike, since the chances
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of a rally to 30 are many times greater than the chances of a rally to 35.
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3. Do not invest a large percentage of available trading capital in bullish calendar
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spreads. Since these are such low-cost spreads, one should be able to follow this
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rule easily and still diversify into several positions.
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FOLLOW-UP ACTION
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If the underlying stock should rally before the near-term call expires, the bullish cal
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endar spreader must never consider "legging" out of the spread, or consider cover
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ing the short call at a loss and attempting to ride the long call. Either action could
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turn the initial small, limited loss into a disastrous loss. Since the strategy hinges on |