38 lines
2.9 KiB
Plaintext
38 lines
2.9 KiB
Plaintext
314 Part Ill: Put Option Strategies
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position. Another advantage of buying the protection initially is that one is protected
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if the stock should experience a gap opening or a trading halt. If he already owns the
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protection, such stock price movement in the direction of the protection is of little
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consequence. However, if he was planning to buy the protection as a follow-up
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action, the sudden surge in the stock price may ruin his strategy.
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The overall profit potential of this position is smaller than that of the normal
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straddle write, since the premium paid for the long call will be lost if the stock is
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below 50 at expiration. However, the automatic risk-limiting feature of the long call
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may prove to be worth more than the decrease in profit potential. The strategist has
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peace of mind in a rally and does not have to worry about unlimited losses accruing
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to the upside.
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Downside protection for a straddle writer can be achieved in a similar manner
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by buying an out-of-the-money put at the outset.
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Example: With XYZ at 45, one might write the January 45 straddle for 7 and buy a
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January 40 put for l point if he is concerned about the stock dropping in price.
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It should now be fairly easy to see that the straddle writer could limit risk in
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either direction by initially buying both an out-of-the-money call and an out-of-the
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money put at the same time that the straddle is written. The major benefit in doing
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this is that risk is limited in either direction. Moreover, the margin requirements are
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significantly reduced, since the whole position consists of a call spread and a put
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spread. There are no longer any naked options. The detriment of buying protection
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on both sides initially is that commission costs increase and the overall profit poten
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tial of the straddle write is reduced, perhaps significantly, by the cost of two long
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options. Therefore, one must evaluate whether the cost of the protection is too large
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in comparison to what is received for the straddle write. This completely protected
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strategy can be very attractive when available, and it is described again in Chapter 23,
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Spreads Combining Calls and Puts.
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In summary, any strategy in which the straddle writer also decides to buy pro
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tection presents both advantages and disadvantages. Obviously, the risk-limiting fea
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ture of the purchased options is an advantage. However, the seller of options does not
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like to purchase pure time value premium as protection at any time. He would gen
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erally prefer to buy intrinsic value. The reader will note that, in each of the protec
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tive buying strategies discussed above, the purchased option has a large amount of
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time value premium left in it. Therefore, the ·writer must often try to strike a delicate
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balance between trying to limit his risk on one hand and trying to hold down the
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expenses of buying long options on the other hand. In the final analysis, however, the
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risk must be limited regardless of the cost. |