39 lines
2.8 KiB
Plaintext
39 lines
2.8 KiB
Plaintext
Cl,opter 20: The Sale of a Straddle
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XYZ January 45 put, l; and
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XYZ January 50 call, 3.
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311
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The January 50 call price is included because it will be part of the follow-up strategy.
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Notice that this straddle has a considerable amount of time value premium remain
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Ing in it, and thus would be rather expensive to buy back at the current time.
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Suppose, however, that the straddle writer does not touch the January 45 straddle
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tliat he is short, but instead buys the January 50 call for protection to the upside.
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Since this call costs 3 points, he will now have a position with a total credit of 4 points.
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(The straddle was originally sold for 7 points credit and he is now spending 3 points
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for the call at 50.) This action of buying a call at a higher strike than the striking price
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of the straddle has limited the potential loss to the upside, no matter how far the
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stock might run up. If XYZ is anywhere above 50 at expiration, the put will expire
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worthless and the writer will have to pay 5 points to close the call spread short
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January 45, long January 50. This means that his maximum potential loss is 1 point
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plus commissions if XYZ is anywhere above 50 at expiration.
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In addition to being able to limit the upside loss, this type of follow-up action
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still allows room for potential profits. If XYZ is anywhere between 41 and 49 at expi
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ration - that is, less than 4 points away from the striking price of 45 - the writer will
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he able to buy the straddle back for less than 4 points, thereby making a profit.
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Thus, the straddle writer has both limited his potential losses to the upside and
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also allowed room for profit potential should the underlying stock fall back in price
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toward the original striking price of 45. Only severe price reversal, with the stock
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falling back below 40, would cause a large loss to be taken. In fact, by the time the
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stock could reverse its current strong upward momentum and fall all the way back to
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40, a significant amount of time should have passed, thereby allowing the writer to
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purchase the straddle back with only a relatively small amount of time premium left
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in it.
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This follow-up strategy has an effect on the margin requirement of the position.
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When the calls are bought as protection to the upside, the writer has, for margin
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purposes, a bearish spread in the calls and an uncovered put. The margin for this
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position would normally be less than that required for the straddle that is 5 points
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in-the-money.
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A secondary move is available in this strategy.
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Example: The stock continues to climb over the short term and the out-of-the
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money put drops to a price of less than ½ point. The straddle writer might now
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consider buying back the put, thereby leaving himself with a bear spread in the
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calls. His net credit left in the position, after buying back the put at ½, would be |