35 lines
2.3 KiB
Plaintext
35 lines
2.3 KiB
Plaintext
Gaining Exposure • 203
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overvalued and it drops before the shorter option expires, you must pay the
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entire bid-ask spread and the broker and exchange fees again when you roll
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your put option.
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The moral of the story is that when selecting tenors for puts, you need
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to balance the existence of upward market drift (which lends weight to the
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argument for choosing shorter tenors) with bid-ask spreads and other fees
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(which lends weight to the argument for longer tenors). If you can iden-
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tify a catalyst, you can plan the tenor of the option investment based on
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the expected catalyst. However, it’s unfortunate but mysteriously true that
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bearish catalysts have a tendency to be ignored by the market’s “happy ma-
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chine” until the instant when suddenly they are not and the shares collapse.
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The key for a short seller is to be in the game when the market realizes the
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stock’s overvaluation.
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Strike Price Selection
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When it comes to strike prices, short sellers find themselves fighting drift
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in much the same way as they did when selecting tenors. A short seller with
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a position in stocks can be successful if the shares he or she is short go up
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less than other stocks in the market. The short exposure acts as a hedge to
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the portfolio as a whole, and if it loses less money than the rest of the port-
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folio gains, it can be thought of as a successful investment.
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However, the definition for success is different for buyers of a put
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option, who must not only see their bearish bets not go up by much but
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rather must see their bearish bets fall if they are to enjoy a profit. If the
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investor wanting bearish exposure decides to gain it by buying OTM puts,
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he or she must—as we learned in the section about leverage—accept a
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realized loss as soon as the put is purchased. If, on the other hand, the
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investor wants to minimize the realized loss accepted up front, he or she
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must accept that he or she is in a levered bearish position so that every
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1 percent move to the upside for the stock generates a loss larger than 1
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percent for the position.
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There is another bearish strategy that you can use by accepting
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exposure that I will discuss in the next section, but for investors who are
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gaining bearish exposure, there is no way to work around the dilemma of
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the option-based short seller just mentioned. |