37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
O,apter 16: Put Option Buying 269
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anywhere below 50, the October 50 will have some value and the investor will be able
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to recover something from the position. This is distinctly different from the original
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put holding of the October 45, whereby the maximum loss would be incurred unless
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the stock were below 45 at expiration. Thus, the introduction of the spread also
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reduces the chances of having to realize the maximum loss.
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In summary, the put holder faced with an unrealized loss may be able to create
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a spread by selling twice the number of puts that he is currently long and simultane
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ously buying the put at the next higher strike. This action should be used only if the
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spread can be transacted at a small debit or, preferably, at even money (zero debit).
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The spread position offers a much better chance of breaking even and also reduces
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the possibility of having to realize the maximum loss in the position. However, the
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introduction of these loss-limiting measures reduces the maximum potential of the
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position if the underlying stock should subsequently decline in price by a significant
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amount. Using this spread strategy for puts would require a margin account, just as
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calls do.
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THE CALENDAR SPREAD STRATEGY
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Another strategy is sometimes available to the put holder who has an unrealized loss.
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If the put that he is holding has an intermediate-term or long-term expiration date,
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he might be able to create a calendar spread by selling the near-term put against the
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put that he currently holds.
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Example: An investor bought an XYZ October 45 put for 3 points when the stock was
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at 45. The stock rises to 48, moving in the wrong direction for the put buyer, and his
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put falls in value to 1 ½. He might, at that time, consider selling the near-term July
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45 put for 1 point. The ideal situation would be for the July 45 put to expire worth
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less, reducing the cost of his long put by 1 point. Then, if the underlying stock
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declined below 45, he could profit after July expiration.
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The major drawback to this strategy is that little or no profit will be made - in
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fact, a loss is quite possible - if the underlying stock falls back to 45 or below before
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the near-term July option expires. Puts display different qualities in their time value
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premiums than calls do, as has been noted before. With the stock at 45, the differ
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ential between the July 45 put and the October 45 put might not widen much at all.
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This would mean that the spread has not gained anything, and the spreader has a loss
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equal to his commissions plus the initial unrealized loss. In the example above, ifXYZ
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dropped quickly back to 45, the July 45 might be worth 1 ½ and the October worth
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2½. At this point, the spreader would have a loss on both sides of his spread: He sold
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the July 45 put for 1 and it is now 1 ½; he bought the October 45 for 3 and it is now |