37 lines
3.0 KiB
Plaintext
37 lines
3.0 KiB
Plaintext
274 Part Ill: Put Option Strategies
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At the opposite end of the spectrum, the stock owner might buy an in-the
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money put as protection. This would quite severely limit his profit potential, since the
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underlying stock would have to rise above the strike and more for him to make a
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profit. However, the in-the-money put provides vast quantities of downside protec
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tion, limiting his loss to a very small amount.
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Example: XYZ is again at 40 and there is an October 45 put selling for 5½. The stock
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owner who purchases the October 45 put would have a maximum risk of½ point, for
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he could always exercise the put to sell stock at 45, giving him a 5-point gain on the
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stock, but he paid 5½ points for the put, thereby giving him an overall maximum loss
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of ½ point. He would have difficulty making any profit during the life of the put,
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however. XYZ would have to rise by more than 5½ points (the cost of the put) for
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him to make any total profit on the position by October expiration.
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The deep in-the-money put purchase is overly conservative and is usually not a
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good strategy. On the other hand, it is not wise to purchase a put that is too deeply
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out-of-the-money as protection. Generally, one should purchase a slightly out-ofthe
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money put as protection. This helps to achieve a balance between the positive feature
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of protection for the common stock and the negative feature of limiting profits.
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The reader may find it interesting to know that he has actually gone through this
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analysis, back in Chapter 3. Glance again at the profit graph for this strategy of using
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the put purchase to protect a common stock holding (Figure 17-1). It has exactly the
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same shape as the profit graph of a simple call purchase. Therefore, the call purchase
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and the long put/long stock strategies are equivalent. Again, by equivalent it is meant
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that they have similar profit potentials. Obviously, the ownership of a call differs sub
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stantially from the ownership of common stock and a put. The stock owner continues
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to maintain his position for an indefinite period of time, while the call holder does not.
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Also, the stockholder is forced to pay substantially more for his position than is the call
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holder, and he also receives dividends whereas the call holder does not. Therefore,
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"equivalent" does not mean exactly the same when comparing call-oriented and put
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oriented strategies, but rather denotes that they have similar profit potentials.
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In Chapter 3, it was determined that the slightly in-the-money call often offers
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the best ratio between risk and reward. When the call is slightly in-the-money, the
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stock is above the striking price. Similarly, the slightly out-of-the-money put often
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offers the best ratio between risk and reward for the common stockholder who is buy
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ing the put for protection. Again, the stock is slightly above the striking price. Actually,
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since the two positions are equivalent, the same conclusions should be arrived at; that
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is why it was stated that the reader has been through this analysis previously. |