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I fully agree with Bob's post, but would like to bring up one important
point. Here is one more case.
Case 6: You have perused cases 1 through 5 and are now more than ever
convinced of the value of options. Expecting the S&P to rise at least 20
points within the next two weeks, you buy a July 1250 call at a price of
only $4,200. You don't need to worry about a world crisis occurring
overnight while you are asleep. The next morning, while placing the order
for your new BMW, you are overcome with a feeling of pity for those futures
traders who are hedged with puts but have a much larger than necessary part
of their money tied up in margin deposits...
It's true! Usually it is neither desirable nor advisable to go long an S&P
futures contract and hedge this exposure by purchasing an S&P Put option.
Why? Because the very same market position can be established by simply
buying an S&P Call.
These two positions are totally equivalent, including delta, gamma, time
decay and all. And yet, in the first case S&P initial margin plus put
premium will bind about $7,600 of the trader's capital, while the (totally
equivalent) call position can be established for only $4,200, and even saves
one trade's worth of commission and slippage.
I have posted about this at length on the Realtraders list, where I also
demonstrated a little-known method of using vector equations to find the
correct option equivalents. Since these equivalents are usually overlooked I
thought perhaps it might be helpful to at least mention the phenomenon here.
Best,
Michael Suesserott
> -----Ursprungliche Nachricht-----
> Von: Bob Fulks [mailto:bfulks@xxxxxxxxxxxx]
> Gesendet: Wednesday, July 04, 2001 15:24
> An: DH
> Cc: Omega List
> Betreff: Re: AW: Options - was:Globex2 in home
>
>
> At 1:31 PM -0700 7/3/01, DH wrote:
>
> >Well, then we've gone in a big circle. The starting point of the
> >exercise was to hedge the futures trade with options. If you cover your
> >futures trade when the options are deep in the money, you're booking a
> >big loss on the futures trade and *hoping* the big profit on your
> >options position won't disappear before expiration.
>
> Let's consider several examples.
>
> Case 1: You are long one SP contract which has an equity exposure of
> 1250 * $250 = $312,500 and are holding this position overnight. Some
> world crisis occurs overnight while you are asleep. The next morning
> futures open limit-down. The limit keeps moving down. You cannot get
> out. Eventually, your broker liquidates your position with huge loss.
> Soon after, the world comes to it's senses and the price moves back
> to near where it started but you are out with the huge loss.
>
> Case 2: You are long one SP contract and long one SP futures Put with
> a strike price 5% under the market in the same account. The crisis
> occurs overnight, the market tanks, and your Put becomes
> in-the-money. You account loss is limited to the 5% or about $15,000
> which is less than your account balance. You broker does nothing. The
> market comes back and your account recovers most of the loss. Some
> time later you exit both positions.
>
> Case 3: As in Case 2 except that the market stays down and your Put
> remains in-the-money. You now have to unwind the two positions in
> some orderly way but there is no rush since your are "market-neutral"
> so long as the Put is in-the-money. So you wait for some opportune
> time and exit both positions. Your loss is limited to the 5%
> ($15,000).
>
> Case 4: You are long one SP contract and long one SP futures Put with
> a strike price 5% under the market in the same account. Nothing
> unusual occurs in the market. You sell the Put position sometime
> later with some loss in the time value. This loss is the "insurance
> premium" you paid for the "insurance". But since you had the
> insurance in place, you were able to trade larger positions and hold
> positions overnight safely so you made enough more money trading the
> larger positions than the insurance cost you.
>
> Case 5: Real estate is appreciating rapidly and you have an
> opportunity to buy this rental property for a $312,500 with very
> little of your own money. You buy the property and buy a fire
> insurance policy to cover the value. The property doesn't burn down.
> You sell the property later for $400,000. You made $87,500, less the
> cost of the fire insurance. You obviously would not have even
> considered doing without the insurance.
>
> Think about it...
>
> Bob Fulks
>
>
>
>
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