32 lines
2.1 KiB
Plaintext
32 lines
2.1 KiB
Plaintext
for the move to reverse itself. If she didn’t have the trade on now, would she
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sell ten 65 puts at 1.07 with Johnson & Johnson at $65? Based on her
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original intention, unless she believes strongly now that a breakout through
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$65 with follow-through momentum is about to take place, she will likely
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take the money and run.
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Stacie also must handle this trade differently from Brendan in the event
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that the trade is a loser. Her trade has a higher delta. An adverse move in the
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underlying would affect Stacie’s trade more than it would Brendan’s. If
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Johnson & Johnson declines, she must be conscious in advance of where
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she will cover.
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Stacie considers both how much she is willing to lose and what potential
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stock-price action will cause her to change her forecast. She consults a
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stock chart of Johnson & Johnson. In this example, we’ll assume there is
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some resistance developing around $64 in the short term. If this resistance
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level holds, the trade becomes less attractive. The at-expiration breakeven is
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$63.25, so the trade can still be a winner if Johnson & Johnson retreats. But
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Stacie is looking for the stock to approach $65. She will no longer like the
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risk/reward of this trade if it looks like that price rise won’t occur. She
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makes the decision that if Johnson & Johnson bounces off the $64 level
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over the next couple weeks, she will exit the position for fear that her
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outlook is wrong. If Johnson & Johnson drifts above $64, however, she will
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ride the trade out.
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In this example, Stacie is willing to lose 1.00 per contract. Without taking
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into account theta or vega, that 1.00 loss in the option should occur at a
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stock price of about $63.28. Theta is somewhat relevant here. It helps
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Stacie’s potential for profit as time passes. As time passes and as the stock
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rises, so will theta, helping her even more. If the stock moves lower (against
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her) theta helps ease the pain somewhat, but the further in-the-money the
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put, the lower the theta.
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Vega can be important here for two reasons: first, because of how implied
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volatility tends to change with market direction, and second, because it can
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be read as an indication of the market’s expectations. |