28 lines
1.9 KiB
Plaintext
28 lines
1.9 KiB
Plaintext
flexible enough to tailor a position around a forecast. It’s about minimizing
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the unwanted risks and optimizing exposure to the intended risks. Still,
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there always exists a trade-off in that where there is the potential for profit,
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there is the possibility of loss—you can always be wrong.
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Recalling the at-expiration diagram and examining the greeks, the best-
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case scenario is intuitive: the stock at $75 at expiration. The biggest theta
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would be right at that strike. But that strike price is also the center of the
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biggest negative gamma. It is important to guard against upward movement
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into negative delta territory, as well as movement lower where the position
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has a slightly positive delta. Exhibit 16.6 shows what happens to the greeks
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of this trade as the stock price moves.
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EXHIBIT 16.6 Ratio vertical spread at various prices for the underlying.
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As the stock begins to rise from $71 a share, negative deltas grow fast in
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the short term. Careful trend monitoring is necessary to guard against a
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rally. The key, however, is not in knowing what will happen but in skillfully
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hedging against the unknown. The talented option trader is a disciplined
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risk manager, not a clairvoyant.
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One of the risks that the trader willingly accepted when placing this trade
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was short gamma. But when the stock moves and deltas are created,
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decisions have to be made. Did the catalyst(s)—if any—that contributed to
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the rise in stock price change the outlook for volatility? If not, the decision
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is simply whether or not to hedge by buying stock. However, if it appears
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that volatility is on the rise, it is not just a delta decision. A trader may
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consider buying some of the short options back to reduce volatility
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exposure.
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In this example, if the stock rises and it’s feared that volatility may
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increase, a good choice may be to buy back some of the short 75-strike
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calls. This has the advantage of reducing delta (buy enough deltas to flatten |