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Strategies & Market Trends : Tech Stock Options -- Ignore unavailable to you. Want to Upgrade?

To: donald sew who wrote (47686)	7/13/1998 9:31:00 AM
From: ViperChick Secret Agent 006.9	Read Replies (2) \| Respond to of 58727

Your girlfriend Maria is an unabashed bull however, she did mention that the bonds were getting whacked which ever way we open I wouldnt trust it as the direction for the day for sure... Maria update on MER for those playing my current love exchange2000.com she says AMZN weak....uhhhh...I have it up 2/8

To: donald sew who wrote (47686)	7/14/1998 6:47:00 AM
From: Johnny Canuck	Read Replies (1) \| Respond to of 58727

Everyone here probably know this but it is worth repeating. **************************************************** Canadian Financial Post Tuesday, July 14, 1998 Options Bear call spreads limit risk in overvalued market By RICHARD CROFT For The Financial Post ÿEuphoria over the defeat of Japan's Liberal Democratic Party would seem to indicate that the problems in Asia are over. Analysts are saying that U.S. corporate profits will do better than expected in the third and fourth quarters. And Internet stocks will be so profitable that by the turn of the century, today's stock prices will seem like bargains -- at least you would think as much based on their recent performance. ÿFor example, Internet-based bookseller Amazon.com Inc. was a US$20 stock last September. Last week, it closed at just under US$100 after trading as high as US$143. This, from a company that has yet to produce any meaningful earnings. In fact, analysts estimate that Amazon will lose US63› a share in 1999, which seems to me to discount the price-earnings model as an analytical tool. ÿOf course I could be wrong, but this looks like the "irrational exuberance" Alan Greenspan talked about last year. ÿHow else can you explain the 20.1% year-to-date return in the U.S. stock market? The Standard & Poor's 500 composite index -- the most acceptable standard of U.S. stock market activity -- is trading at levels 33.4% higher than where it was on Oct. 27, 1997. ÿIn case you forgot, that was the day the U.S. stock market fell by more than 7% when the crisis in Asia first surfaced. At the time, it was defined as a crisis that could potentially have a serious long-term effect on U.S. corporate profits. But here we are just nine months later and all seems right with the world. What's changed? ÿI'm not sure I have the answer, but concerned investors might consider using index options to taper their exposure to the market. ÿInvestors who think the market may be overvalued need to rethink how they use index options to hedge their portfolio. One approach is the bear call spread. A bear call spread involves buying and selling index calls with different strike prices and the same expiration date. ÿFor example, one could buy S&P 100 index puts. The S&P 100 index -- symbol OEX -- is the most popular index option contract. There is no problem getting in and out of this market in a hurry, with more than 300,000 contracts changing hands daily. ÿIf you buy puts on the index they will rise in value as the market declines. The OEX also has a 98% correlation with the S&P 500 index. Think of the puts as insurance with a deductible -- which, in this case, is the cost of the option. ÿThe problem with this approach is the cost of the deductible, which I talked about a couple of weeks ago. Index options are almost always overpriced. For example, the volatility implied by the OEX options is about 20%, which would be okay if the historical volatility of the OEX was also near 20%. However, its historical volatility has been closer to 16%. ÿThere is some debate about why index options are so expensive. Lawrence McMillan, of McMillan Analysis Corp. in Morristown, N.J. (www.optionstrategist.com), believes that it is a simple case of supply and demand. ÿMost individual investors tend to buy index options rather than write them. You cannot own the underlying index; therefore, you cannot sell a covered option. And some brokerage firms will not allow investors to sell uncovered index options, which keeps supply in check. More demand plus less supply yields higher prices. ÿThe bear call spread is useful because it addresses the high cost of trading index options. When you initiate a trade, you pay more to buy calls, but you can also receive more when you sell them. ÿFor example, with the S&P 500 composite index at 1164, you might sell the S&P 500 August 1180 calls at US$20 and buy the S&P 500 August 1200 calls at US$11.75. This position creates a US$8.25 credit in your account, or US$825 a spread. Note that each index option is exerciseable into 100 units of the underlying index. ÿThe worst case scenario would occur if the S&P 500 composite index closed above 1200 on the August expiration. If the S&P closed at exactly 1200 in August, on the expiration day the August 1180 calls would be worth US$20 a unit while the August 1200 calls would be worthless. You would have to repurchase the August 1180 calls at US$20 a unit. ÿThe total loss on this position would be the US$20 cost to close out the August 1180 calls, minus the US$8.25 credit you initially received. Thus the total loss equals US$11.75 a unit, or US$1,175 a spread. ÿAt least with the spread, your worst case scenario is limited and the maximum loss is predetermined. ÿThe maximum profit occurs if the index closes below 1180 by the August expiration. ÿIn this case, both options would expire worthless, and you would simply retain the initial credit of US$8.25 a unit, or US$825 a spread. For the record, a close above 1180 by the August expiration would be a record high for the S&P 500. It would also equate to a 23.8% return in the first eight months of 1998. ÿNote that we are using S&P 500 options rather than the OEX. That is because the S&P 500 options are European settled, which means that the options cannot be exercised before expiration -- an important feature if you are implementing a spread using index options. The OEX options are U.S.-styled, which means they can be exercised at any time during the life of the option. ÿInvestors may be correct in their assessment of the future direction of North American stock markets, and perhaps individual stock values will continue to rise. The index bear call spread provides some short-term insurance in case they do not. ÿ Richard Croft is president of Croft Financial Group, a Toronto-based investment counselling firm. ÿ