34 lines
2.1 KiB
Plaintext
34 lines
2.1 KiB
Plaintext
202 • The Intelligent Option Investor
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realized loss because it cannot be recovered. If the stock fails to move into
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the area of exposure before option expiration, there will be no profit to
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offset this realized loss.
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In economic terms, this transaction allows an investor to sell short
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an overvalued company without accepting an uncertain risk of loss if the
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stock rises. Instead of the uncertain risk of loss, the investor must pay the
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fixed premium. This strategy obeys the same rules of leverage as discussed
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earlier in this book, with ITM put options offering less leverage but a great-
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er cushion before realizing a loss than do ATM or OTM put options.
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T enor Selection
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Shorting stocks, which is what you are doing when you buy put op-
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tions, is hard work, not for the faint of heart. There are a couple of
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reasons for this:
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1. Markets generally go up, and for better or worse, a rising tide usu-
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ally does lift all boats.
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2. Even when a company is overvalued, it is hard to know what cata-
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lyst will make that fact obvious to the rest of the market and when.
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In the words of Jim Chanos, head of the largest short-selling hedge fund
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in the world, the market is a “giant positive reinforcement machine. ”
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1
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It is psychologically difficult to hold a bearish position when it seems
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like the whole world disagrees with you. All these difficulties in taking
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bearish positions are amplified by options because options are levered
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instruments, and losses feel all the more acute when they occur on a
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levered position.
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My rule for gaining bullish exposure is to pick the longest-tenor op-
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tion possible. I made the point that by buying LEAPS, you can enjoy a
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likely upward drift that exceeds the drift assumed by option pricing. When
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buying puts, you are on the opposite side of this drift factor (i.e., the “ris-
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ing tide lifts all boats” factor), and every day that the stock does not fall is
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another day of time value that has decayed without you enjoying a profit.
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On the other hand, if you decide not to spend as much on time value and
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buy a shorter-tenor put option, unless the market realizes that the stock is |