Exhibit 12.4 shows Susie’s position.
EXHIBIT 12.4 Delta-neutral short ATM call, long stock position.
Her delta was just about flat. The delta for the 50 calls was 0.54 per
contract. Selling a 20-lot creates 10.80 short deltas for her overall position.
After buying 1,100 shares, she was left long 0.20 deltas, about the
equivalence of being long 20 shares. Where did her risk lie? Her biggest
concern was negative gamma. Without even seeing a chart of the stock’s
price, we can see from the volatility chart that this stock can have big
moves on earnings. In October, earnings caused a more than 10-point jump
in realized volatility, to its highest level during the year shown. Whether the
stock rose or fell is irrelevant. Either event means risk for a premium seller.
The positive theta looks good on the surface, but in fact, theta provided
Susie with no significant benefit. Her plan was “in and out and nobody gets
hurt.” She got into the trade right before the earnings announcement and out
as soon as implied volatility dropped off. Ideally, she’d like to hold these
types of trades for less than a day. The true prize is vega.
Susie was looking for about a 10-point drop in IV, which this option class
had following the October and January earnings reports. April had a big
drop in IV, as well, of about eight or nine points. Ultimately, what Susie is
looking for is reversion to the mean.
She gauges the normal level of volatility by observing where it is before
and after the surges caused by earnings. From early November to mid- to
late- December, the stock’s IV bounced around the 25 percent level. In the
month of February, the IV was around 25. After the drop-off following
April earnings and through much of May, the IV was closer to 20 percent.
In June, IV was just above 25. Susie surmised from this chart that when no