33 lines
2.3 KiB
Plaintext
33 lines
2.3 KiB
Plaintext
will be a loser if the underlying is below the lower of the two break-even
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points—in this case $65.75. This point is found by subtracting the premium
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received from the strike. Before expiration, negative gamma adversely
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affects profits as the underlying falls. The lower the underlying is trading
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below the strike price, the greater the drain on P&(L) due to the positive
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delta of the short put.
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It is the same proposition if the underlying is above $70 at expiration. But
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in this case, it is the short call that would be in-the-money. The higher the
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underlying price, the more the −1.00 delta adversely impacts P&(L). If at
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expiration the underlying is above the higher breakeven, which in this case
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is $74.25 (the strike plus the premium), the trade is a loser. The higher the
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underlying, the worse off the trade. Before expiration, negative gamma
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creates negative deltas as the underlying climbs above the strike, eating
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away at the potential profit, which is the net premium received.
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The best-case scenario is that the underlying is right at $70 at the closing
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bell on expiration Friday. In this situation, neither option is ITM, meaning
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that the 4.25 premium is all profit. In reaping the maximum profit, both
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time and price play roles. If the position is closed before expiration, implied
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volatility enters into the picture as well.
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It’s important to note that just because neither option is ITM if the
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underlying is right at $70 at expiration, it doesn’t mean with certainty that
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neither option will be assigned. Sometimes options that are ATM or even
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out-of-the-money (OTM) get assigned. This can lead to a pleasant or
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unpleasant surprise the Monday morning following expiration. The risk of
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not knowing whether or not you will be assigned—that is, whether or not
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you have a position in the underlying security—is a risk to be avoided. It is
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the goal of every trader to remove unnecessary risk from the equation.
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Buying the call and the put for 0.05 or 0.10 to close the position is a small
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price to pay when one considers the possibility of waking up Monday
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morning to find a loss of hundreds of dollars per contract because a position
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you didn’t even know you owned had moved against you. Most traders
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avoid this risk, referred to as pin risk, by closing short options before
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expiration. |