23 lines
1.5 KiB
Plaintext
23 lines
1.5 KiB
Plaintext
Trading Rho
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While it’s possible to trade rho, most traders forgo this niche for more
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dynamic strategies with greater profitability. The effects of rho are often
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overshadowed by the more profound effects of the other greeks. The
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opportunity to profit from rho is outweighed by other risks. For most
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traders, rho is hardly ever even looked at.
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Because LEAPS have higher rho values than corresponding short-term
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options, it makes sense that these instruments would be appropriate for
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interest-rate plays. But even with LEAPS, rho exposure usually pales in
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comparison with that of delta, theta, and vega.
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It is not uncommon for the rho of a long-term option to be 5 to 8 percent
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of the option’s value. For example, Exhibit 7.2 shows a two-year LEAPS on
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a $70 stock with the following pricing-model inputs and outputs:
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EXHIBIT 7.2 Long 70-strike LEAPS call.
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The rho is +0.793, or about 5.8 percent of the call value. That means a 25-
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basis-point rise in rates contributes to only a 20-cent profit on the call.
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That’s only about 1.5 percent of the call’s value. On one hand, 1.5 percent is
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not a very big profit on a trade. On the other hand, if there are more rate
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rises at following Fed meetings, the trader can expect further gains on rho.
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Even if the trader is compelled to wait until the next Fed meeting to make
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another $0.20—or less, as rho will get smaller as time passes—from a
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second 25-basis-point rate increase, other influences will diminish rho’s
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significance. If over the six-week period between Fed meetings, the |