32 lines
2.2 KiB
Plaintext
32 lines
2.2 KiB
Plaintext
the LEAPS 60 call delta is about 0.77. This disparity continues as XYZ
|
||
moves higher.
|
||
Perhaps Susanne had implied volatility (IV) on her mind as well as time
|
||
decay. These long-term ATM LEAPS options have vegas more than three
|
||
times the corresponding May’s. If IV for both the May and the LEAPS is at
|
||
a yearly low, LEAPS might be a better buy. A one- or two-point rise in
|
||
volatility if IV reverts to its normal level will benefit the LEAPS call much
|
||
more than the May.
|
||
Theta, delta, gamma, and vega are typical considerations with most
|
||
trades. Because this option is long term, in addition to these typical
|
||
considerations, Susanne needs to take a good hard look at rho. The LEAPS
|
||
rho is significantly higher than that of its short-term counterpart. A one-
|
||
percentage-point change in the interest rate will change Susanne’s P&(L) by
|
||
$0.64—that’s about 8.5 percent of the value of her option—and she has
|
||
nearly two years of exposure to interest rate fluctuations. Certainly, when
|
||
the Federal Reserve Board has great concerns about growth or inflation,
|
||
rates can rise or fall by more than one percentage point in one year’s time.
|
||
It is important to understand that, like the other greeks, rho is a snapshot
|
||
at a particular price, volatility level, interest rate, and moment in time. If
|
||
interest rates were to fall by one percentage point today, it would cause
|
||
Susanne’s call to decline in value by $0.64. If that rate drop occurred over
|
||
the life of the option, it would have a much smaller effect. Why? Rate
|
||
changes closer to expiration have less of an effect on option values.
|
||
Assume that on the trade date, when the LEAPS has 639 days until
|
||
expiration, interest rates fall by 25 basis points. The effect will be a decline
|
||
in the value of the call of 0.16—one-fourth of the 0.638 rho. If the next rate
|
||
cut occurs six months later, the rho of the LEAPS will be smaller, because it
|
||
will have less time until expiration. In this case, after six months, the rho
|
||
will be only 0.46. Another 25-basis-point drop will hurt the call by $0.115.
|
||
After another six months, the option will have a 0.26 rho. Another quarter-
|
||
point cut costs Susanne only $0.065. Any subsequent rate cuts in ensuing
|
||
months will have almost no effect on the now short-term option value. |