37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
518 Part V: Index Options and Futures
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made a rather large move by the time the futures open. Such a small gap is normal
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ly not extremely damaging to the naked writer.
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One cannot assume that an index can never gap open widely - if something
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drastic were to happen in the marketplace that caused opening gaps in many stocks,
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then a gap could appear in the index itself. The worst case of such a gap, percentage
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wise, was the stock market crash in 1987 when the major indices such as OEX and
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S&P 500 opened down over 20 points. Nothing has come close to that before or
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since, but the possibility always exists that it could happen again. Therefore, one can
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not assume that naked option writing of index options is a low-risk strategy; howev
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er, it is generally less risky than naked option writing of equity options.
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HANDLING EARLY ASSIGNMENT OF CASH-BASED OPTIONS
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The greatest problem that a spreader of index options has is the possibility of early
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assignment. This removes his hedge on one side of his position, exposing him to
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much more risk than he had wanted or anticipated.
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One can often obtain a clue before early assignment occurs by observing the
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price of the in-the-money options. If they are trading at a discount, one can expect
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assignment to be more likely.
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Example: '.lYX is trading at 357 a few days before expiration of the January options.
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The stock market rallies heavily near the close, and the January 340 calls are trading
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with a market of 16½ to 16¾ after 4 pm EST. Since parity is 17 for these calls, it is
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likely that a writer will receive an assignment notice in the morning.
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The strategist who observes this situation taking place must make a rather quick
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decision. Since the market has rallied heavily on the close, it is likely that arbitrageurs
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or institutional accounts who are long index options are going to exercise them. The
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cynic among us would even think that they might be short stocks as well which they
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plan to cover in the morning. Notice that the effect of hedged call option sellers (i.e.,
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spreaders) receiving assignment notices will be to make them all long the market.
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The short side of their spread will have been removed via assignment, and they will
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be left with only the long side. Therefore, in order to liquidate or hedge, they will
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have to sell stocks or index futures and options in the morning. This would force the
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market down temporarily and would be a boon to anyone who was short overnight.
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The spreader's first potential choice of action is to notice what is happening near
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the close of trading and to try to exercise his long calls since he expects assignment
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of his short calls. The assignment, of course, is not certain - he is merely projecting
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it. Therefore, he could outfox himself and end up being very short if he did not
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r~ceive an assignment notice on his short calls. |