Example 1
Imagine a trader, Arlo, is studying the following chart of Agilent
Technologies Inc. (A). See Exhibit 17.1 .
EXHIBIT 17.1 Agilent Technologies Inc. daily candles.
Source : Chart courtesy of Livevol® Pro ( www.livevol.com )
The stock has been in an uptrend for six weeks or so. Close-to-close
volatility hasn’t increased much. But intraday volatility has increased
greatly as indicated by the larger candles over the past 10 or so trading
sessions. Earnings is coming up in a week in this example, however implied
volatility has not risen much. It is still “cheap” relative to historical
volatility and past implied volatility. Arlo is bullish. But how does he play
it? He needs to use what he knows about the greeks to guide his decision.
Arlo doesn’t want to hold the trade through earnings, so it will be a short-
term trade. Thus, theta is not much of a concern. The low-priced volatility
guides his strategy selection in terms of vega. Arlo certainly wouldn’t want
a short-vega trade. Not with the prospect of implied volatility potential
rising going into earnings. In fact, he’d actually want a big positive vega
position. That rules out a naked/cash-secured put, put credit spread and the
likes.
He can probably rule out vertical spreads all together. He doesn’t need to
spread off theta. He doesn’t want to spread off vega. Positive gamma is
attractive for this sort of trade. He wouldn’t want to spread that off either.
Plus, the inherent time component of spreads won’t work well here. As
discussed in Chapter 9, the bulk of vertical spreads profits (or losses) take
time to come to fruition. The deltas of a call spread are smaller than an
outright call. Profits would come from both delta and theta, if the stock rises
to the short strike and positive theta kicks in.