43 lines
2.2 KiB
Plaintext
43 lines
2.2 KiB
Plaintext
Chapter 12: Combining Calendar and Ratio Spreads 227
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itself is a rather high-probability event, because the stock is initially below the strik
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ing price. In addition, the spread can make large potential profits if the stock rallies
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after the near-term calls expire. Although this is a much less probable event, the prof
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its that can accrue add to the expected return of the spread. The only time the spread
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loses is when the stock rallies quickly, and the strategist should close out the spread
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in that case to limit losses.
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Although Table 12-2 is not mathematically definitive, it can be seen that this
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strategy has a positive expected return. Small profits occur more frequently than
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small losses do, and sometimes large profits can occur. These expected outcomes,
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when coupled with the fact that the strategist may utilize collateral such as stocks,
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bonds, or government securities to set up these spreads, demonstrate that this is a
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viable strategy for the advanced investor.
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TABLE 12-2.
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Profitability of ratio calendar spreading.
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Event
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Stock never rallies above
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strike
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Stock rallies above strike in a
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short time
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Stock rallies above strike after
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near-term call expires
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Outcome
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Small profit.
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Small loss if defensive
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action employed
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Large potential profit
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DELTA-NEUTRAL CALENDAR SPREADS
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Probability
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Large probability
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Small probability
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Small probability
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The preceding discussion dealt with a specific kind of ratio calendar spread, the out
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of-the-money call spread. A more accurate ratio can be constructed using the deltas
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of the calls involved, similar to the ratio spreads in Chapter 11. The spread can be
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created with either out-of-the-money calls or in-the-money calls. The former has
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naked calls, while the latter has extra long calls. Both types of ratio calendars are
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described.
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In either case, the number of calls to sell for each one purchased is determined
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by dividing the delta of the long call by the delta of the short call. This is the same
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for any ratio spread, not just calendars.
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Example: Suppose XYZ is trading at 45 and one is considering using the July 50 call
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and the April 50 call to establish a ratio calendar spread. This is the same situation |