26 lines
1.8 KiB
Plaintext
26 lines
1.8 KiB
Plaintext
premium. How fast can it go to zero without the movement hurting me? To
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determine this, the trader must study both theta and delta.
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The first step in the process is determining which month and strike call to
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sell. In this example, Harley-Davidson Motor Company (HOG) is trading at
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about $69 per share. A trader, Bill, is neutral to slightly bullish on Harley-
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Davidson over the next three months. Exhibit 5.7 shows a selection of
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available call options for Harley-Davidson with corresponding deltas and
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thetas.
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EXHIBIT 5.7 Harley-Davidson calls.
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In this example, the May 70 calls have 85 days until expiration and are
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2.80 bid. If Harley-Davidson remained at $69 until May expiration, the 2.80
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premium would represent a 4 percent profit over this 85-day period (2.80 ÷
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69). That’s an annualized return of about 17 percent ([0.04 / 85)] × 365).
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Bill considers his alternatives. He can sell the April (57-day) 70 calls at
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2.20 or the March (22-day) 70 calls at 0.85. Since there is a different
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number of days until expiration, Bill needs to compare the trades on an
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apples-to-apples basis. For this, he will look at theta and implied volatility.
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Presumably, the March call has a theta advantage over the longer-term
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choices. The March 70 has a theta of 0.032, while the April 70’s theta is
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0.026 and the May 70’s is 0.022. Based on his assessment of theta, Bill
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would have the inclination to sell the March. If he wants exposure for 90
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days, when the March 70 call expires, he can roll into the April 70 call and
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then the May 70 call (more on this in subsequent chapters). This way Bill
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can continue to capitalize on the nonlinear rate of decay through May.
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Next, Bill studies the IV term structure for the Harley-Davidson ATMs
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and finds the March has about a 19.2 percent IV, the April has a 23.3 |