44 lines
2.5 KiB
Plaintext
44 lines
2.5 KiB
Plaintext
268
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TABLE 16-6.
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Summary of rolling-up transactions.
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Original trade:
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Later:
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Net position:
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Buy 1 October 45 put for 3
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with XYZ at 45
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With XYZ at 48, sell 2
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October 45's for 11/2 each
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and buy l October 50 put for 3
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Long 1 October 50 put
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Short 1 October 45 put
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Part Ill: Put Option Strategies
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$300 debit
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$300 credit
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$300 debit
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$300 debit
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The effect of creating this spread is that the investor has not increased his risk
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at all, but has raised the break-even point for his position. That is, if XYZ merely falls
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a small distance, he will be able to get out even. Without the effect of creating the
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spread, the put holder would need XYZ to fall back to 42 at expiration in order for
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him to break even, since he originally paid 3 points for the October 45 put. His orig
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inal risk was $300. IfXYZ continues to rise in price and the puts in the spread expire
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worthless, the net loss will still be only $300 plus additional commissions. Admittedly,
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the commissions for the spread will increase the loss slightly, but they are small in
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comparison to the debit of the position ($300). On the other hand, if the stock should
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fall back only slightly, to 47 by expiration, the spread will break even. At expiration,
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with XYZ at 47, the in-the-money October 50 put will be worth 3 points and the out
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of-the-money October 45 put will expire worthless. Thus, the investor will recover his
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$300 cost, except for commissions, with XYZ at 47 at expiration. His break-even point
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is raised from 42 to 47, a substantial improvement of his chances for recovery.
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The implementation of this spread strategy reduces the profit potential of the
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position, however. The maximum potential of the spread is 2 points. If XYZ is any
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where below 45 at expiration, the spread will be worth 5 points, since the October 50
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put will sell for 5 points more than the October 45 put. The investor has limited his
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potential profit to 2 points - the 5-point maximum width of the spread, less the 3
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points that he paid to get into the position. He can no longer gain substantially on a
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large drop in price by the underlying stock. This is normally of little concern to the
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put holder faced with an unrealized loss and the potential for a total loss. He gener
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ally would be appreciative of getting out even or of making a small profit. The cre
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ation of the spread accomplishes this objective for him.
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It should also be pointed out that he does not incur the maximum loss of his
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entire debit plus commissions, unless XYZ closes above 50 at expiration. If XYZ is |