spread and a gamma of −0.72, one might think that his delta would increase
to 0.90 with Bed Bath & Beyond a dollar lower (18 − [−0.072 × 1.00]). But
because a week has passed, his delta would actually get somewhat more
positive. The shorter-term call’s delta will get smaller (closer to zero) at a
faster rate compared to the longer-term call because it has less time to
expiration. Thus, the positive delta of the long-term option begins to
outweigh the negative delta of the short-term option as time passes.
In this scenario, Richard would have almost broken even because what
would be lost on stock price movement, is made up for by theta gains.
Richard can sell about 100 shares of Bed Bath & Beyond to eliminate his
immediate directional risk and stem further delta losses. The good news is
that if Bed Bath & Beyond declines more after this hedge, the profit from
the short stock offsets losses from the long delta. The bad news is that if
BBBY rebounds, losses from the short stock offset gains from the long
delta.
After Richard’s hedge trade is executed, his delta would be zero. His
other greeks remain unchanged. The idea is that if Bed Bath & Beyond
stays at its new price level of $56.50, he reaps the benefits of theta
increasing with time from $18 per day. Richard is accepting the new price
level and any profits or losses that have occurred so far. He simply adjusts
his directional exposure to a zero delta.