26 lines
1.8 KiB
Plaintext
26 lines
1.8 KiB
Plaintext
The Double Whammy
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With the stock around $64, there is a negative vega of about seven cents. As
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the stock moves lower, away from the strike, the vega gets a bit smaller.
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However, the market conditions that would lead to a decline in the price of
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Johnson & Johnson would likely cause implied volatility (IV) to rise. If the
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stock drops, Stacie would have two things working against her—delta and
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vega—a double whammy. Stacie needs to watch her vega. Exhibit 5.6
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shows the vega of Stacie’s put as it changes with time and direction.
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EXHIBIT 5.6 Johnson & Johnson 65 put vega.
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If after one week passes Johnson & Johnson gaps lower to, say, $63.00 a
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share, the vega will be 0.043 per contract. If IV subsequently rises 5 points
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as a result of the stock falling, vega will make Stacie’s puts theoretically
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worth 21.5 cents more per contract. She will lose $215 on vega (that’s 0.043
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vega × 5 volatility points × 10 contracts) plus the adverse delta/gamma
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move.
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A gap opening will cause her to miss the opportunity to stop herself out at
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her target price entirely. Even if the stock drifts lower, her targeted stop-loss
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price will likely come sooner than expected, as the option price will likely
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increase both by delta/gamma and vega resulting from rising volatility. This
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can cause her to have to cover sooner, which leaves less room for error.
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With this trade, increases in IV due to market direction can make it feel as if
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the delta is greater than it actually is as the market declines. Conversely, IV
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softening makes it feel as if the delta is smaller than it is as the market rises.
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The second reason IV has importance for this trade (as for most other
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strategies) is that it can give some indication of how much the market thinks
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the stock can move. If IV is higher than normal, the market perceives there |