31 lines
1.7 KiB
Plaintext
31 lines
1.7 KiB
Plaintext
Long OTM Call
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Kim can reduce her exposure to theta and vega by buying an OTM call. The
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trade-off here is that she also reduces her immediate delta exposure.
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Depending on how much Kim believes Disney will rally, this may or may
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not be a viable trade-off. Imagine that instead of buying one Disney March
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35 call, Kim buys one Disney March 37.50 call, for 0.20.
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There are a few observations to be made about this alternative position.
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First, the net premium, and therefore overall risk, is much lower, 0.20
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instead of 1.10. From an expiration standpoint, the breakeven at expiration
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is $37.70 (the strike price plus the call premium). Since Kim plans on
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exiting the position after about three weeks, the exact break-even point at
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the expiration of the contract is irrelevant. But the concept is the same: the
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stock needs to rise significantly. Exhibit 4.6 shows how Kim’s concerns
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translate into greeks.
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EXHIBIT 4.6 Greeks for Disney 35 and 37.50 calls.
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35 Call37.50 Call
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Delta 0.57 0.185
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Gamma0.1660.119
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Theta −0.013−0.007
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Vega 0.0480.032
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Rho 0.0230.007
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This table compares the ATM call with the OTM call. Kim can reduce her
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theta to half that of the ATM call position by purchasing an OTM. This is
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certainly a favorable difference. Her vega is lower with the 37.50 call, too.
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This may or may not be a favorable difference. That depends on Kim’s
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opinion of IV.
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On the surface, the disparity in delta appears to be a highly unfavorable
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trade-off. The delta of the 37.50 call is less than one third of the delta of the
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35 call, and the whole motive for entering into this trade is to trade
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direction! Although this strategy is very delta oriented, its core is more
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focused on gamma and theta. |