19 lines
1.3 KiB
Plaintext
19 lines
1.3 KiB
Plaintext
EXHIBIT 16.4 Short ratio spread at expiration.
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This strategy is a mirror image of the backspread discussed previously in
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this chapter. With limited risk to the downside, the maximum loss to the
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trade is the initial debit of 1 if the stock is below $70 at expiration and all
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the calls expire. There is a maximum profit potential of 4 if the stock is at
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the short strike at expiration. There is unlimited loss potential, since a short
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net delta is created on the upside, as one short 75 call is covered by the long
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70 call, and one is naked. The breakevens are at $71 and $79.
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Low Volatility
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With the stock at $71, gamma and vega are both negative. Just as the
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backspread was a long volatility play at this underlying price, this ratio
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vertical is a short-vol play here. As in trading a short straddle, the name of
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the game is low volatility—meaning both implied and realized.
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This strategy may require some gamma hedging. But as with other short
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volatility delta-neutral trades, the fewer the negative scalps, the greater the
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potential profit. Delta covering should be implemented in situations where
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it looks as if the stock will trend deep into negative-gamma territory.
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Murphy’s Law of trading dictates that delta covering will likely be wrong at
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least as often as it is right. |