33 lines
2.1 KiB
Plaintext
33 lines
2.1 KiB
Plaintext
Legging Out
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There are many ways to exiting a straddle. In the right circumstances,
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legging out is the preferred method. Instead of buying and selling stock to
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lock in profits and maintain delta neutrality, traders can reduce their
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positions by selling off some of the calls or puts that are part of the straddle.
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In this technique, when the underlying rises, traders sell as many calls as
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needed to reduce the delta to zero. As the underlying falls, they sell enough
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puts to reduce their position to zero delta. As the stock oscillates, they
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whittle away at the position with each hedging transaction. This serves the
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dual purpose of taking profits and reducing risk.
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A trader, Susan, has been studying Acme Brokerage Co. (ABC). Susan
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has noticed that brokerage stocks have been fairly volatile in recent past.
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Exhibit 15.3 shows an analysis of Acme’s volatility over the past 30 days.
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EXHIBIT 15.3 Acme Brokerage Co. volatility.
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Stock Price Realized VolatilityFront-Month Implied Volatility
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30-day high $78.6630-day high 47%30-day high 55%
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30-day low $66.9430-day low 36%30-day low 34%
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Current px $74.80Current vol 36%Current vol 36%
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During this period, Acme stock ranged more than $11 in price. In this
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example, Acme’s volatility is a function of interest rate concerns and other
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macroeconomic issues affecting the brokerage industry as a whole. As the
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stock price begins to level off in the latter half of the 30-day period, realized
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volatility begins to ebb. The front month’s IV recedes toward recent lows as
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well. At this point, both realized and implied volatility converge at 36
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percent. Although volatility is at its low for the past month, it is still
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relatively high for a brokerage stock under normal market conditions.
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Susan does not believe that the volatility plaguing this stock is over. She
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believes that an upcoming scheduled Federal Reserve Board announcement
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will lead to more volatility. She perceives this to be a volatility-buying
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opportunity. Effectively, she wants to buy volatility on the dip. Susan pays
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5.75 for 20 July 75-strike straddles.
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Exhibit 15.4 shows the analytics of this trade with four weeks until
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expiration. |