36 lines
2.6 KiB
Plaintext
36 lines
2.6 KiB
Plaintext
Chapter 23: Spreads Combining Calls and Puts 3S3
|
||
strategy discussed in this section is merely a combination of a diagonal bearish call
|
||
spread and a diagonal bullish put spread and is known as a "diagonal butterfly
|
||
spread." The same concept that was described in Chapter 14 - being able to make
|
||
more on the short-term call than one originally paid for the long-term call - applies
|
||
here as well. One enters into a credit position with the hope of being able to buy back
|
||
the near-term written options for a profit greater than the cost of the long options. If
|
||
he is able to do this, he will own options for free and could make large profits if the
|
||
underlying stock moves substantially in either direction. Even if the stock does not
|
||
move after the buy-back, he still has no risk. The risk occurs prior to the expiration
|
||
of the near-term options, but this risk is limited. As a result, this is an attractive strat
|
||
egy that, when operated over a period of market cycles, should produce some large
|
||
profits. Ideally, these profits would offset any small losses that had to be taken. Since
|
||
large commission costs are involved in this strategy, the strategist is reminded that
|
||
establishing the spreads in quantity can help to reduce the percentage effect of the
|
||
commissions.
|
||
SELECTING THE SPREADS
|
||
Now that the concepts of these three strategies have been laid out, let us define
|
||
selection criteria for them. The "calendar combination" is the easiest of these strate
|
||
gies to spot. One would like to have the stock nearly halfway between two striking
|
||
prices. The most attractive positions can normally be found when the striking prices
|
||
are at least 10 points apart and the underlying stock is relatively volatile. The opti
|
||
mum time to establish the "calendar combination" is two or three months before the
|
||
near-term options expire. Additionally, one would like the sum of the prices of the
|
||
near-term options to be equal to at least one-half of the cost of the longer-term
|
||
options. In the example given in the previous section on the "calendar combination,"
|
||
the near-term combination was sold for 5 points, and the longer-term combination
|
||
was bought for 8 points. Thus, the near-term combination was worth more than one
|
||
half of the cost of the longer-term combination. These five criteria can be summa
|
||
rized as follows:
|
||
1. Relatively volatile stock.
|
||
2. Stock price nearly midway between two strikes.
|
||
3. Striking prices at least 10 points apart.
|
||
4. Two or three months remaining until near-term expiration.
|
||
5. Price of near-term combination greater than one-half the price of the longer
|
||
term combination. |