37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
20: The Sale of a Straddle 309
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gh it is 7 points in-the-money. This is not unusual in a bullish situation.
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ver, the put might be worth 1 ½points.This is also not unusual, as out-of-the
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y puts with a large amount of time remaining tend to hold time value premium
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well. Thus, the straddle writer would have to pay 10½ points to buy back this
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dle, even though it is at the break-even point, 7 points in-the-money on the call
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This example is included merely to demonstrate that it is a misconception to
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ieve that one can always buy the straddle back at the break-even point and hold
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losses to mere fractions of a point by doing so. This type of buy-back strategy
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ks best when there is little time remaining in the straddle. In that case, the
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options will indeed be close to parity and the straddle will be able to be bought back
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for close to its initial value when the stock reaches the break-even point.
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Another follow-up strategy that can be employed, similar to the previous one
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but with certain improvements, is to buy back only the in-the-money option when it
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reaches a price equal to that of the initial straddle price.
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~mple: Again using the same situation, suppose that when XYZ began to climb
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heavily, the call was worth 7 points when the stock reached 50. The in-the-money
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option the call - is now worth an amount equal to the initial straddle value. It could
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then be bought back, leaving the out-of-the-money put naked. As long as the stock
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then remained above 45, the put would expire worthless. In practice, the put could
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be bought back for a small fraction after enough time had passed or if the underly
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Ing stock continued to climb in price.
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This type of follow-up action does not depend on taking action at a fixed stock
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price, but rather is triggered by the option price itself. It is therefore a dynamic sort
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of follow-up action, one in which the same action could be applied at various stock
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prices, depending on the amount of time remaining until expiration. One of the prob
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lems with closing the straddle at the break-even points is that the break-even point is
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C)nly a valid break-even point at expiration. A long time before expiration, this stock
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price will not represent much of a break-even point, as was pointed out in the last
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example. Thus, buying back only the in-the-money option at a fixed price may often
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be a superior strategy. The drawback is that one does not release much collateral by
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buying back the in-the-money option, and he is therefore stuck in a position with
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little potential profit for what could amount to a considerable length of time. The
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collateral released amounts to the in-the-money amount; the writer still needs to
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C.'Ollateralize 20% of the stock price.
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One could adjust this follow-up method to attempt to retain some profit. For
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example, he might decide to buy the in-the-money option when it has reached a |