Pay More, Profit More by Vikram Murarka
Paying a higher premium may mean an
opportunity for greater profits. Look at this
example of the GBP/USD trade.
It is an open secret that every corporate
hedger wants to pay zero for an option that he buys. Banks oblige by
constructing “zero-cost” strategies. The
concept of zero-cost structures has become
so ingrained in the market psyche that when,
at a seminar, we suggested buying call
spreads at a cost, an experienced hedger
asked, “But aren’t call spreads supposed to
be zero cost?” No!
Like anyone else, we would love to be able to buy cheap options. However, we are open to the idea
of not only paying premium, but also the idea of paying
higher premium if there is an opportunity to make greater
profits. If this sounds contradictory, perhaps this trade example
IN-THE-MONEY PUT OPTION
The GBP/USD was trading near 1.9690 (Figure 1) on the
morning of January 4, 2008, looking to fall toward 1.95 over
a one-month period and possibly toward 1.90 over three to
four months. While an eventual fall looked certain, an interim
rally toward 1.98–99 could not be ruled out.