21 lines
1.5 KiB
Plaintext
21 lines
1.5 KiB
Plaintext
The sooner the price rise occurs, the better. It means less time for theta to
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eat away profits. If Kim must hold the position for the entire three weeks,
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she needs a good pop in the stock to make it worth her while. At a $37 share
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price, the call is worth about 0.50, assuming all other market influences
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remain constant. That’s about a 150 percent profit. At $38, Exhibit 4.9
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reveals the call value to be 1.04. That’s a 420 percent profit.
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On one hand, it’s hard for a trader like Kim not to get excited about the
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prospect of making 420 percent on an 8 percent move in a stock. On the
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other hand, Kim has to put things in perspective. When the position is
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established, the call has a 0.185 delta. By the trader’s definition of delta,
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that means the call is estimated to have about an 18.5 percent chance of
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expiring in-the-money. More than four out of five times, this position will
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be trading below the strike at expiration.
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Although Kim is not likely to hold the position until expiration, this
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observation tells her something: she’s starting in the hole. She is more likely
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to lose than to win. She needs to be compensated well for her risk on the
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winners to make up for the more prevalent losers.
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Buying OTM calls can be considered more speculative than buying ITM
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or ATM calls. Unlike what the at-expiration diagrams would lead one to
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believe, OTM calls are not simply about direction. There’s a bit more to it.
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They are really about gamma, time, and the magnitude of the stock’s move |