37 lines
2.7 KiB
Plaintext
37 lines
2.7 KiB
Plaintext
Chapter 25: LEAPS 403
|
||
passed, the straddle seller could reasonably expect to have a profit of about 40% of
|
||
the original straddle price. However, if one had sold a 2-year LEAPS straddle, and
|
||
the stock were relatively unchanged after two months, he would only have a profit of
|
||
about 7% of the original sale price. This should not be surprising in light of what has
|
||
been demonstrated about the decaying of long-term options. It should make the
|
||
straddle seller somewhat leery of using LEAPS, however, unless he truly thinks the
|
||
options are overpriced.
|
||
Second, consider follow-up action. Recall that in Chapter 20, it was shown that
|
||
the bane of the straddle seller was the whipsaw. A whipsaw occurs when one makes
|
||
a follow-up protective action on one side (for instance, he does something bullish
|
||
because the underlying stock is rising and the short calls are losing money), only to
|
||
have the stock reverse and come crashing back down. Obviously, the more time left
|
||
until expiration, the more likely it is that a whipsaw will occur after any follow-up
|
||
action, and the more expensive it will be, since there will be a lot of time value pre
|
||
mium left in the options that are being repurchased. This makes LEAPS straddle
|
||
selling less than attractive.
|
||
LEAPS straddles may look expensive because of their large absolute price, and
|
||
therefore may appear to be attractive straddle sale candidates. However, the price is
|
||
often justified, and the seller of LEAPS straddles will be fighting sudden stock move
|
||
ments without getting much benefit from the passage of time. The best time to sell
|
||
LEAPS straddles is when short-term rates are high and volatilities are high as well
|
||
(i.e., the options are overpriced). At least, in those cases, the seller will derive some
|
||
real benefit if rates or volatilities should drop.
|
||
SPREADS USING LEAPS
|
||
Any of the spread strategies previously discussed can be implemented with LEAPS
|
||
as well, if one desires. The margin requirements are the same for LEAPS spreads as
|
||
they are for ordinary equity option spreads. One general category of spread lends
|
||
itself well to using LEAPS: that of buying a longer-term option and selling a short
|
||
term one. Calendar spreads, as well as diagonal spreads, fall into that category.
|
||
The combinations are myriad, but the reasoning is the same. One wants to own
|
||
the option that is not so subject to time decay, while simultaneously selling the
|
||
option that is quite subject to time decay. Of course, since LEAPS are long-term and
|
||
therefore expensive, one is generally taking on a large debit in such a spread and
|
||
may have substantial risk if the stock performs adversely. Other risks may be pres
|
||
ent as well. As a means of demonstrating these facts, let us consider a simple bull
|
||
spread using calls. |