About those over-priced put options...
If you really believe an option is over-priced,
you can make money selling it. The market makers
are required to make a market for them, which means
they are prepared to buy them from you as well as
sell them to you.
So over-price options don't exist, at least without
similarly over-priced call options. The reason is
that there is a simple arbitrage between them that
would be a money mint if the puts and calls are not
priced equivalently. "Priced equivalently" means having
the same time premium for a given strike and date. The
time premium is just the cost of the option minus the
intrinsic value. The intrinsic value is the amount the
option is "in the money", or zero if it is out of the money.
Lets do a little example. In order to make bucks off of over-
priced puts and under priced calls, just buy the call and
sell the put, then hedge by selling short the underlying
security. Similarly, if the calls are over-priced, just
sell the calls, buy the puts, and hedge by buying the
security. In either case your postion is riskless if you hold
to expiration.
Example: Closing prices of Amazon today:
AMZN Closed at 71 3/4
ZQNVM October 65 Put, AMZN, closed at 11 1/4 x 11 3/4
ZQNJM October 65 Call, AMZN, closed at 16 7/8 x 17 3/8
cboe.pcquote.com
Buy the call @ 17 3/8. Sell the put @ 11 1/4. You are out
$612.50 per contract. Short sell AMZN at 71 3/4. Now
wait until the October expiration.
If the stock closes at 65 in October, the put and call both
expire worthless, and your short sale returns 71 3/4 - 65
= 6 3/4 = $675.00 If the stock closes at 70 in October, the
call will be worth $500, the put is worthless, and your
short sale will be worth $175, for a total of $675.00.
Similarly, if the stock closes at 60 in October, the put
will be worth ($500), the short sale will return $1175,
and your position will be worth $675.
In other words, you have locked in a return of $675 with
an investment of only $612.50, for a profit of $62.50.
(Unfortunately, commissions have eaten you alive. :)
Anyway, puts and calls can be arbitraged against each
other for riskless cash if they get too far out of whack.
But don't worry, the market makers would eat each other
alive to make those riskless profits, and they don't
have commissions, so you're not going to make any
money this way. :(
By the way, I sold my AMZN puts today for a tidy 2-day
return of almost 10%. Unfortunately, this is less than
I would have made short selling AMZN on margin over
the same interval.
The real problem with options is the illiquid market,
the high commissions and spreads, and (for the buyer)
the high time premiums. But these are problems for
both the put and call purchaser.
-- Carl |
