Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Politics : Ask Michael Burke -- Ignore unavailable to you. Want to Upgrade?

To: eabDad who wrote (34466)	10/24/1998 3:05:00 PM
From: Knighty Tin	Read Replies (3) \| Respond to of 132070

Z, First, where are you getting 8%? <G> The in the money call does not cost more than carrying the long stock, except back in the days of yore when stocks had dividends. But you are not dealing with folks who hold long stocks. They buy options either as part of a hedging operation (synthetic long stock, conversions, reverse conversions, butterflys, bull or bear spreads, etc.) or, like me, as a spec on the upside or downside of a stock. With the hedger, he has to look at the return of all the parts of his position. When a call option or a put option that he is long approaches parity, i.e., no or very little time premium, that is usually the point of maximum return. For example, on a straight call bull debit spread, you may be long 50s and short 60s on a stock. If you did it when the stock was at $50, and it is now at $70, and within a month or so of expiration, you probably have little profit potential left in your spread. Your $50 call will be very near parity and so will your $60 call that you are short. When this is late December and it expires the third Friday in Jan, that is especially likely to be true. So, if you have earned the maximum profit or close to the maximum profit on the position, and still have time to run, the wise trade is to unwind that position and do something else, even if that something else is to hold cash. Most of the time, you unwind the options. Why continue to take risk on a done deal? But a market maker who takes the other side of your trade sure won't hold a call deep in the money call at zero or a below money market rate of return. If he can't lay it off at parity, he will exercise and lay off the stock in the market. He does not carry the stock, either. For a speculator such as myself, I buy out of the money puts and calls. When they get in the money, I now have turned a small investment into a large risk. If a put goes from $3 to $20, I don't want to risk my $17 of profit. I sell the deep in the money. If I still hate the underlying stock, I will buy a new out of the money call, probably further out in time. Once again, the market maker or specialist isn't going to hold that call or put at parity. If he can't sell it, he will exercise. In the general course of events, it is usually wiser for the floor to sell the options. So, you will usually not be exercised early. But many folks try these deep in the money strategies near year end and that may cause a glut of options on the dealer's desks, which could lead to early exercise. You cannot look at the options as derivative instruments in this case, because they are the main instruments for those taking the other side of the trade. They will not hold something with a lot of downside risk and a cost of carry, as they all borrow to buy long. If the stock figures into the transaction because of an exercise, it is fleeting. It will be gone before it hits the MMs or specialists book. I wrote a letter to Barron's about this back in 1996 when they were talking about a brilliant strategy, not tax related, of writing deep in the money $45 puts on Micron Technology. Not only did the money manager who did it get exercised, he subsequently got hammered as the stock fell to $17. Now that was a great strategy. <G> Your tax strategy is MUCH smarter than that. MB