37 lines
2.7 KiB
Plaintext
37 lines
2.7 KiB
Plaintext
Chapter 25: LEAPS 385
|
||
Those familiar with holding equity calls and puts are more accustomed to seeing
|
||
an option lose 25% of its value in possibly as little as four or five weeks' time. Thus, the
|
||
advantage of holding the LEAPS is obvious from the viewpoint of slower time decay.
|
||
This observation leads to the obvious question: "When is the best time to sell my
|
||
call and repurchase a longer-term one?" Referring again to the figure above may help
|
||
answer the question. Note that for the at-the-money option, the curve begins to bend
|
||
dramatically upward soon after the 6-month time barrier is passed. Thus, it seems log
|
||
ical that to minimize the effects of time decay, all other things being equal, one would
|
||
sell his long at-the-money call when it has about 6 months of life left and simultane
|
||
ously buy a 2-year LEAPS call. This keeps his time decay exposure to a. minimum.
|
||
The out-of-the-money call is more radical. Figure 25-4 shows that the call that
|
||
is 20% out-of-the-money begins to decay much more rapidly (percentagewise) at
|
||
sometime just before it reaches one year until expiration. The same logic would dic
|
||
tate, then, that if one is trading out-of-the-money options, he would sell his option
|
||
held long when it has about one year to go and reestablish his position by buying a 2-
|
||
year LEAPS option at the same time.
|
||
ADVANTAGES OF BUYING HCHEAP"
|
||
It has been demonstrated that rising interest rates or rising volatility would make the
|
||
price of a LEAPS call increase. Therefore, if one is attempting to participate in
|
||
LEAPS speculative call buying strategies, he should be more aggressive when rates
|
||
and volatilities are low.
|
||
A few sample prices may help to demonstrate just how powerful the effects of
|
||
rates and volatilities are, and how they can be a friend to the LEAPS call buyer. Suppose
|
||
that one buys a 2-year LEAPS call at-the-money when the following situation exists:
|
||
XYZ: 100
|
||
January 2-year LEAPS call with strike of 100: 14
|
||
Short-term interest rates: 3%
|
||
Volatility: below average (historically)
|
||
For the purposes of demonstration, suppose that the current volatility is low for XYZ
|
||
(historically) and that 3% is a low level for rates as well. If the stock moves up, there
|
||
is no problem, because the LEAPS call will increase in price. But what if the stock
|
||
drops or stays unchanged? Is all hope of a profit lost? Actually, no. If interest rates
|
||
increase or the volatility that the calls trade at increases, we know the LEAPS call will
|
||
increase in value as well. Thus, even though the direction in which the stock is mov
|
||
ing may be unfavorable, it might still be possible to salvage one's investment. Table
|
||
25-3 shows where volatility would have to be or where short-term rates would have |