34 lines
2.1 KiB
Plaintext
34 lines
2.1 KiB
Plaintext
Accepting Exposure • 219
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Looking at this diagram closely, you should be able to see several
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things:
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1. The investor who is short this put certainly has a notable unrealized
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loss on his or her position. Y ou can tell this because the put the
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investor sold is now much more valuable than at the time of
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the original sale (more of the range of exposure is carved out by
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the BSM cone now). When you sell something at one price and the
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value of that thing goes up in the future, you suffer an opportunity
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loss on your original sale.
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2. With the drop in price and the cut in fair value, the downside ex-
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posure on this stock still looks overvalued.
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3. If the company were to perform so that its share price eventually
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hit the new, reduced best-case valuation mark, the original short-
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put position would generate a profit—albeit a smaller profit than
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the one originally envisioned.
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At this point, there are a couple of choices open to the investor:
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1. Convert the unrealized loss on the short-put position to a realized
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one by buying $50-strike puts to close the position (a.k.a. cover the
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position).
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2. Leave the position open and manage it in the same way that the
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investor would manage a struggling stock position.
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It is rarely a sound idea to close a short put immediately after the re-
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lease of information that drives down the stock price (the first choice above,
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in other words). At these times, investors are generally panicked, and this
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panic will cause the price of the option you buy to cover to be more expen-
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sive than justified. Waiting a few days or weeks for the fear to drain out of
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the option prices (i.e., for the BSM cone to narrow) and for the stock price
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to stabilize some will usually allow you to close the option position at a more
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favorable price. There is one exception to this rule: if your new valuation
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suggests a fair value at or below the present market price, it is better to close
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the position immediately and realize those losses. If you do not close the
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position, you are simply gambling (as opposed to investing) because you no
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longer have a better than even chance of making money on the investment. |