an extended period of time can produce a loser even if IV rises. Gamma is
potentially connected to the success of this trade, too. If the underlying
moves in either direction, profit from deltas created by positive gamma may
offset the losses from theta. In fact, a big enough move in either direction
can produce a profitable trade, regardless of what happens to IV.
Imagine, for a moment, that this trade is held until expiration. If the stock
is below the strike price at this point, the calls expire. The resulting position
is short 1,000 shares of stock. If the stock is above the strike price at
expiration, the calls can be exercised, creating 2,000 shares of long stock.
Because the trade is already short 1,000 shares, the resulting net position is
long 1,000 shares (2,000 − 1,000). Clearly, the more the underlying stock
moves in either direction the greater the profit potential. The underlying has
to move far enough above or below the strike price to allow the beneficial
gains from buying or selling stock to cover the option premium lost from
time decay. If the trade is held until expiration, the underlying needs to
move far enough to cover the entire premium spent on the calls.
The solid lines forming a V in Exhibit 12.2 conceptually illustrate the
profit or loss for this delta-neutral long call at expiration.
EXHIBIT 12.2 Profit-and-loss diagram for delta-neutral long-call trade.
Because of gamma, some deltas will be created by movement of the
underlying before expiration. Gamma may lead to this being a profitable