Stocks & Commodities V. 26:6 (16-17): Pay More, Profit More by Vikram Murarka
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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 will illustrate.
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.
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 will illustrate.
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.
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