21 lines
1.4 KiB
Plaintext
21 lines
1.4 KiB
Plaintext
EXHIBIT 1.7 SPY protective put.
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The solid kinked line is the protective put (put and stock), and the thin
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dotted line is the outright position in SPY alone, without the put. The most
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Kathleen stands to lose with the protective put is $3.65 per share. SPY can
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decline from $140.35 to $139, creating a loss of $1.35, plus the $2.30
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premium spent on the put. If the stock does not fall and the insuring put
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hence does not come into play, the cost of the put must be recouped to
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justify its expense. The break-even point is $142.65.
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This position implies that Kathleen is still bullish on the Spiders. When
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traders believe a stock or ETF is going to decline, they sell the shares.
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Instead, Kathleen sacrifices 1.6 percent of her investment up front by
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purchasing the put for $2.30. She defers the sale of SPY until the period of
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perceived risk ends. Her motivation is not to sell the ETF; it is to hedge
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volatility.
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Once the anticipated volatility is no longer a concern, Kathleen has a
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choice to make. She can let the option run its course, holding it to
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expiration, at which point it will either expire or be exercised; or she can
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sell the option before expiration. If the option is out-of-the-money, it may
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have residual time value prior to expiration that can be recouped. If it is in-
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the-money, it will have intrinsic value and maybe time value as well. In this
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situation, Kathleen can look at this spread as two trades—one that has |