33 lines
2.0 KiB
Plaintext
33 lines
2.0 KiB
Plaintext
206 • The Intelligent Option Investor
|
||
avoid this extreme downside are worth much more than they are presently
|
||
trading at.
|
||
The entire premium paid must be treated as a realized loss because
|
||
it can never be recovered. If the stock fails to move into one of the areas
|
||
of exposure before option expiration, there will be no profit to offset this
|
||
realized loss.
|
||
There is no reason why you have to buy puts and calls in equal num-
|
||
bers. If you believe that both upside and downside scenarios are materially
|
||
possible but believe that the downside scenario is more plausible, you can
|
||
buy more puts than calls. This is called ratioing a position.
|
||
T enor Selection
|
||
Because the strangle is a combination of two strategies we have already
|
||
discussed, the considerations regarding tenor are the same as for each of
|
||
the components—that is, using the drift advantage in long-term equity an-
|
||
ticipating securities (LEAPS) and buying them or the longest-tenor calls
|
||
available and balancing the fight against drift and the cost of rolling and
|
||
buying perhaps shorter-tenor puts.
|
||
Strike Price Selection
|
||
A strangle is slightly different in nature from its two components—long
|
||
calls and long puts. A strangle is an option investor’s way of expressing
|
||
the belief that the market in general has underestimated the intrinsic
|
||
uncertainty in the valuation of a firm. Options are directional instru-
|
||
ments, but a strangle is a strategy that acknowledges that the investor
|
||
has no clear idea of which direction a stock will move but only that
|
||
its future value under different scenarios is different from its present
|
||
market price.
|
||
Because both purchased options are OTM ones, this implies, in my
|
||
mind, a more speculative investment and one that lends itself to taking
|
||
profit on it before expiration. Nonetheless, my conservatism forces me to
|
||
select strike prices that would allow a profit on the entire position if the
|
||
stock price is at one of the two strikes at expiration. Because I am buying
|
||
exposure to both the upside and the downside, I always like to make sure |