32 lines
2.2 KiB
Plaintext
32 lines
2.2 KiB
Plaintext
Finding the Right Risk
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Mick could lower the theta of his position by selecting a put with a greater
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number of days to expiration. This alternative has its own set of trade-offs:
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lower gamma and higher vega than the 44-day put. He could also select an
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ITM put or an OTM put. Like Kim’s call alternatives, the OTM put would
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have less exposure to time decay, lower vega, lower gamma, and a lower
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delta. It would have a lower premium, too. It would require a bigger price
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decline than the ATM put and would be more speculative.
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The ITM put would also have lower theta, vega, and gamma, but it would
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have a higher delta. It would take on more of the functionality of a short
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stock position in much the same way that Kim’s ITM call alternative did for
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a long stock position. In its very essence, however, an option trade, ITM or
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otherwise, is still fundamentally different than a stock trade.
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Stock has a 1.00 delta. The delta of a stock never changes, so it has zero
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gamma. Stock is not subject to time decay and has no volatility component
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to its pricing. Even though ITM options have deltas that approach 1.00 and
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other greeks that are relatively low, they have two important differences
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from an equity. The first is that the greeks of options are dynamic. The
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second is the built-in leverage feature of options.
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The relationship of an option’s strike price to the stock price can change
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constantly. Options that are ITM now may be OTM tomorrow and vice
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versa. Greeks that are not in play at the moment may be later. Even if there
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is no time value in the option now because it is so far away-from-the-
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money, there is the potential for time premium to become a component of
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the option’s price if the stock moves closer to the strike price. Gamma,
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theta, and vega always have the potential to come into play.
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Since options are leveraged by nature, small moves in the stock can
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provide big profits or big losses. Options can also curtail big losses if used
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for hedging. Long option positions can reap triple-digit percentage gains
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quickly with a favorable move in the underlying. Even though 100 percent
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of the premium can be lost just as easily, one option contract will have far
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less nominal exposure than a similar position in the stock. |