35 lines
2.5 KiB
Plaintext
35 lines
2.5 KiB
Plaintext
G,pter 16: Put Option Buying 259
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ly, the percentage returns from having purchased a cheaper, out-of-the-money put
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will be greater. However, should the underlying stock decline only moderately in
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price, the in-the-rrwney put will often prove to be the better choice. In fact, since a
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put option tends to lose its time value premium quickly as it becomes an in-the
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money option, there is an even greater advantage to the purchase of the in-the
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money put.
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Example: XYZ is at 49 and the following prices exist:
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XYZ, 49;
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XYZ July 45 put, l; and
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XYZ July 50 put, 3.
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If the underlying stock were to drop to 40 by expiration, the July 45 put would be
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worth 5 points, a 400% profit. The July 50 put would be worth 10 points, a 233%
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profit over its initial purchase price of 3. Thus, in a substantial downward move, the
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out-of-the-money put purchase provides higher reward potential. However, if the
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underlying stock drops only moderately, say to t:15, the purchaser of the July 45 put
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would lose his entire investment, since the put would be worthless at expiration. The
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purchaser of the in-the-money July 50 put would have a 2-point profit with XYZ at
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45 at expiration.
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The preceding analysis is based on holding the put until expiration. For the
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option buyer, this is generally an erroneous form of analysis, because the buyer
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generally tends to liquidate his option purchase in advance of expiration. When
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considering what happens to the put option in advance of expiration, it is helpful to
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remember that an in-the-money put tends to lose its time premium rather quickly.
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In the example above, the July 45 put is completely composed of time value pre
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mium. If the underlying stock begins to drop below 45, the price of the put will not
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increase as rapidly as would the price of a call that is going into-the-money.
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Example: If XYZ fell by 5 points to 44, definitely a move in the put buyer's favor, he
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may fmd that the July 45 put has increased in value only to 2 or 2½ points. This is
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somewhat disappointing because, with call options, one would expect to do signifi
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cantly better on a 5-point stock movement in his favor. Thus, when purchasing put
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options for speculation, it is generally best to concentrate on in-the-rrwney puts unless
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a very substantial decline in the price of the underlying stock is anticipated.
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Once the put option is in-the-money, the time value premium will decrease
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even in the longer-term series. Since this time premium is small in all series, the put |