32 lines
2.0 KiB
Plaintext
32 lines
2.0 KiB
Plaintext
The goal here is for implied volatility to fall to around 20. If it does, John
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makes $1,254 (6 vol points × 2.09 vega). He also thinks theta gains will
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outpace gamma losses. The following is a two-week examination of one
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possible outcome for John’s trade.
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Week One
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The first week in this example was a profitable one, but it came with
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challenges. John paid for his winnings with a few sleepless nights. On the
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Monday following his entry into the trade, the stock rose to $106. While
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John collected a weekend’s worth of time decay, the $1.25 jump in stock
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price ate into some of those profits and naturally made him uneasy about
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the future.
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At this point, John was sitting on a profit, but his position delta began to
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grow negative, to around −1.22 [(–1.18 × 1.25) + 0.26]. For a $104.75
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stock, a move of $1.25—or just over 1 percent—is not out of the ordinary,
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but it put John on his guard. He decided to wait and see what happened
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before hedging.
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The following day, the rally continued. The stock was at $107.30 by
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noon. His delta was around −3. In the face of an increasingly negative delta,
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John weighed his alternatives: He could buy back some of his calls to offset
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his delta, which would have the added benefit of reducing his gamma as
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well. He could buy stock to flatten out. Lastly, he could simply do nothing
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and wait. John felt the stock was overbought and might retrace. He also still
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believed volatility would fall. He decided to be patient and enter a stop
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order to buy all of his deltas at $107.50 in case the stock continued trending
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up. The XYZ shares closed at $107.45 that day.
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This time inaction proved to be the best action. The stock did retrace.
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Week one ended with Federal XYZ back down around $105.50. The IV of
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the straddle was at 23. The straddle finished up week one offered at $4.10.
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Week Two
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The future was looking bright at the start of week two until Wednesday.
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Wednesday morning saw XYZ gap open to $109. When you have a short
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straddle, a $3.50 gap move in the underlying tends to instantly give you a |