Libby is really focusing on theta. It is currently about $0.03 per day but
will increase if the put stays close-to-the-money. In two weeks, the time
premium will have decayed significantly. A move downward will help, too,
as the −0.419 delta indicates. Exhibit 5.11 displays an array of theoretical
values of the put at eight days until expiration as the stock price changes.
EXHIBIT 5.11 HOG 70 put values at 8 days to expiry.
As long as Harley-Davidson stays below the strike price, Libby can look
at her put from a premium-over-parity standpoint. Below the strike, the
intrinsic value of the put doesn’t matter too much, because losses on
intrinsic value are offset by gains on the stock. For Libby, all that really
matters is the time value. She sold the puts at 0.85 over parity. If Harley-
Davidson is trading at $68 with eight days to go, she can buy her puts back
for 0.12 over parity. That’s a 73-cent profit, or $730 on her 10 contracts.
This doesn’t account for any changes in the time value that may occur as a
result of vega, but vega will be small with Harley-Davidson at $68 and
eight days to go. At this point, she would likely close down the whole
position—buying the puts and buying the stock—to take a profit on a
position that worked out just about exactly as planned.
Her risk, though, is to the upside. A big rally in the stock can cause big
losses. From a theoretical standpoint, losses are potentially unlimited with
this type of trade. If the stock is above the strike, she needs to have a mental
stop order in mind and execute the closing order with discipline.