Would I Do It Now? Rule
To follow this rule, ask yourself, “If I did not already have this position,
would I do it now? Would I establish the position at the current market
prices, given the current market scenario?” If the answer is no, then the
solution is simple: Exit the trade.
For example, if after one week material news is released and Johnson &
Johnson is trading higher, at $64.50 per share, and the November 65 call is
trading at 0.75, Brendan must ask himself, based on the price of the stock
and all known information, “If I were not already short the calls, would I
short them now at the current price of 0.75, with the stock trading at
$64.50?”
Brendan’s opinion of the stock is paramount in this decision. If, for
example, based on the news that was announced he is now bullish, he
would likely not want to sell the calls at 0.75—he only gets $0.09 more in
option premium and the stock is 0.50 closer to the strike. If, however, he is
not bullish, there is more to consider.
Theta can be of great use in decision making in this situation. As the
number of days until expiration decreases and the stock approaches $65
(making the option more at-the-money), Brendan’s theta grows more
positive. Exhibit 5.3 shows the theta of this trade as the underlying rises
over time.
EXHIBIT 5.3 Theta of Johnson & Johnson.
When the position is first established, positive theta comforts Brendan by
showing that with each passing day he gets a little closer to his goal—to
have the 65 calls expire out-of-the-money (OTM) and reap a profit of the
entire 66-cent premium. Theta becomes truly useful if the position begins to
move against him. As Johnson & Johnson rises, the trade gets more