37 lines
2.9 KiB
Plaintext
37 lines
2.9 KiB
Plaintext
Chapter 11: Ratio Call Spreads 219
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of them are bought for 8 points, the spreader would not have to buy the remaining 3
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until they were selling around 13. Thus, he could wait longer to the upside before
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reducing the spread ratio to 1:1 (a bull spread). A formula can be applied to deter
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mine the price one would have to pay for the additional long calls, to convert the ratio
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spread into a bull spread. If the calls are bought, such a bull spread would break even
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with the stock above the higher striking price at expiration:
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Break-even cost of Number of short calls x Difference in strikes -Total debit to date
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long calls - Number of naked calls
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In the simple 2: 1 example, the number of short calls was 2, the difference in the
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strikes was 5, the total debit was minus one (-1) (since it was actually a 1.:.point cred
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it), and the number of naked calls is 1. Thus, the break-even cost of the additional
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long call is [2 x 5- (-1)(1)]/l = 11. As another verification of the formula, consider
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the 10:5 spread at the same prices. The initial credit of this spread would be 5 points,
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and the break-even cost of the five additional long calls is 11 points each. Assume that
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the spreader bought two additional April 40's for 8 points each (16 debit). This would
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make the total debit to date of the spread equal to 11 points, and reduce the number
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of naked calls to 3. The break-even cost of the remaining 3 long calls that would need
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to be purchased if the stock continued to rally would be (10 x 5 - 11)/3 = 13. This
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agrees with the observation made earlier. This formula can be used before actual fol
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low-up action is implemented. For example, in the 10:5 spread, if the April 40's were
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. selling for 8, the spreader might ask: "To what would I raise the purchase price of the
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remaining long calls if I buy 2 April 40's for 8 right now?" By using the formula, he
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could easily see that the answer would be 13.
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ADJUSTING WITH THE DELTA
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The theoretically-oriented spreader can use the delta-neutral ratio to monitor his
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spreads as well as to establish them. If the underlying stock moves up in price too far
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or down in price too far, the delta-neutral ratio of the spread will change. The spread
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er can then readjust his spread to a neutral status by buying some additional long calls
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on an upside movement by the stock, or by selling some additional short calls on a
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downward movement by the stock Either action will serve to make the spread delta
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neutral again. The public customer who is employing the delta-neutral adjustment
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method of follow-up action should be careful not to overadjust, because the com
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mission costs would become prohibitive. A more detailed description of the use of
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deltas as a means of follow-up action is contained in Chapter 28 on mathematical
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applications, under the heading "Facilitation or Institutional Block Positioning." The
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general concept, however, is the same as that shown earlier for ratio writing. |