39 lines
3.0 KiB
Plaintext
39 lines
3.0 KiB
Plaintext
310 Part Ill: Put Option Strategies
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value that is 1 point less than the total straddle value initially taken in. This would
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then allow him the chance to make a I-point profit overall, if the other option expired
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worthless. In any case, there is always the risk that the stock would suddenly revers('
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direction and cause a loss on the remaining option as well. This method of follow-up
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action is akin to the ratio writing follow-up strategy of using buy and sell stops on th<'
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underlying stock.
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Before describing other types of follow-up action that are designed to combat
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the problems described above, it might be worthwhile to address the method used in
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ratio writing - rolling up or rolling down. In straddle writing, there is often little to
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be gained from rolling up or rolling down. This is a much more viable strategy in ratio
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writing; one does not want to be constantly moving in and out of stock positions,
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because of the commissions involved. Howeve1~ with straddle writing, once one posi
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tion is closed, there is no need to pursue a similar straddle in that same stock. It may
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be more desirable to look elsewhere for a new straddle position.
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There are two other very simple forms of follow-up action that one might con
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sider using, although neither one is for most strategists. First, one might consider
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doing nothing at all, even if the underlying stock moves by a great deal, figuring that
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the advantage lies in the probability that the stock will be back near the striking price
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by the time the options expire. This action should be used only by the most diversi
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fied and well-heeled investors, for in extreme market periods, almost all stocks may
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move in unison, generating tremendous losses for anyone who does not take some
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sort of action. A more aggressive type off allow-up action would be to attempt to "leg
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out" of the straddle, by buying in the profitable side and then hoping for a stock price
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reversal in order to buy back the remaining side. In the example above, when XYZ
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ran up to 52, an aggressive trader would buy in the put at 1 ½, taking his profit, and
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then hope for the stock to fall back in order to buy the call in cheaper. This is a very
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aggressive type of follow-up action, because the stock could easily continue to rise in
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price, thereby generating larger losses. This is a trader's sort of action, not that of a
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disciplined strategist, and it should be avoided.
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In essence, follow-up action should be designed to do two things: First, to limit
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the risk in the position, and second, to still allow room for a potential profit to be
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made. None of the above types of follow-up action accomplish both of these purpos
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es. There is, however, a follow-up strategy that does allow the straddle writer to limit
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his losses while still allowing for a potential profit.
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Example: After the straddle was originally sold for 7 points when the stock was at 45,
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the stock experiences a rally and the following prices exist:
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XYZ common, 50;
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XYZ January 45 call, 7; |