right, he stands to make $660. If he is wrong? Exhibit 5.1 shows how
Brendan’s calls hold up if they are held until expiration.
EXHIBIT 5.1 Naked Johnson & Johnson call at expiration.
Considering the risk/reward of this trade, Brendan is rightfully concerned
about a big upward move. If the stock begins to rally, he must be prepared
to act fast. Brendan must have an idea in advance of what his pain threshold
is. In other words, at what price will he buy back his calls and take a loss if
Johnson & Johnson moves adversely?
He decides he will buy all 10 of his calls back at 1.10 per contract if the
trade goes against him. (1.10 is an arbitrary price used for illustrative
purposes. The actual price will vary, based on the situation and the risk
tolerance of the trader. More on when to take profits and losses is discussed
in future chapters.) He may choose to enter a good-till-canceled (GTC)
stop-loss order to buy back his calls. Or he may choose to monitor the stock
and enter the order when he sees the calls offered at 1.10—a mental stop
order. What Brendan needs to know is: How far can the stock price advance
before the calls are at 1.10?
Brendan needs to examine the greeks of this trade to help answer this
question. Exhibit 5.2 shows the hypothetical greeks for the position in this
example.
EXHIBIT 5.2 Greeks for short Johnson & Johnson 65 call (per contract).