Day Seven
This was the quiet day of the week, and a welcome respite. On this day, the
stock rose just $0.25. The rise in price helped a bit. Mary was still long 560
deltas from Friday. Negative gamma took only a small bite out of her profit.
The P&(L) can be broken down into the profit attributable to the starting
delta of the trade, the estimated loss from gamma, and the gain from theta.
Mary ends these seven days of trading worse off than she started. What
went wrong? The bottom line is that she sold volatility on an asset that
proved to be volatile. A $4 drop in price of a $42 dollar stock was a big
move. This stock certainly moved at more than 25 percent volatility. Day
four alone made this trade a losing proposition.
Could Mary have done anything better? Yes. In a perfect world, she
would not have covered her negative deltas on day 3 by buying 280 shares
at $41 and another 280 at $42. Had she not, this wouldn’t have been such a
bad week. With the stock ending at $38.25, she lost $1,050 on the 280
shares she bought at $42 ($3.75 times 280) and lost $770 on the 280 shares
bought at $41 ($2.75 times 280). Then again, if the stock had continued
higher, rising beyond $42, those would have been good buys.
Mary can’t beat herself up too much for protecting herself in a way that
made sense at the time. The stock’s $2 rally is more to blame than the fact
that she hedged her deltas. That’s the risk of selling volatility: the stock may
prove to be volatile. If the stock had not made such a move, she wouldn’t
have faced the dilemma of whether or not to hedge.