39 lines
1.5 KiB
Plaintext
39 lines
1.5 KiB
Plaintext
Option Fundamentals • 25
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In fact, many of the option strategies I will introduce in this book
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simply represent a carving up of the risk-reward profile of a long or short
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stock position and isolating one piece of it. To make it more clear and easy
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to remember the rules for breaking even on different strategies, I will actu-
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ally use a different nomenclature from breakeven.
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If a diagram has one or both of the elements of the risk-return profile
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of buying a stock, I will call the breakeven line the effective buy price and
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abbreviate it EBP. For example, if we sell a put option, we accept downside
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risk in the same way that we do when we buy a stock:
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5/18/2012
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-
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20
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40
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60
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80
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100
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120
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140
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160
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180
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200
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5/20/2013 249 499
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Date/Day Count
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Stock Price
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749 999
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EBP = $45
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RED
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Basically, what we are saying when we accept downside risk is that
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we are willing to buy the stock if it goes below the strike price. In return
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for accepting this risk, we are paid $5 in premium, and this cash inflow
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effectively lowers the buying price at which we own the stock. If, when the
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option expires, the stock is trading at $47, we can think of the situation
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not as “being $3 less than the strike price” but rather as “being $2 over the
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b u y p r i c e .”
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Conversely, if a diagram has one or both of the elements of the risk-
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return profile of short selling a stock, I will call the breakeven line the
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effective sell price and abbreviate it ESP. For example, if we buy a put option
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anticipating a fall in the stock, we would represent it graphically like this: |