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The Wishbone Option


Talk about the pre-game prep talk! We take the field this fine Monday morning with renewed vigor and visions of grandeur as we cast our eyes toward the all-star lineup of earnings. Indeed, every sector base will be covered this week, starting with Super Tuesday tomorrow (banking and semiconductor giants) and followed by Industrial Wednesday (aerospace, cyclicals) and Granddaddy Thursday (software!). Hang onto your helmets, team, this promises to be an action packed week.

I wanted to touch briefly on an option strategy that I sometimes employ with hopes of educating you and explaining the process. Often times, you'll see a disclosure on the bottom of this page stating that I'm long XYZ calls and short XYZ common. Many readers have asked what the thought was behind such positioning. Without getting too granular, let's say that XYZ is trading at $25/share. I may choose to position myself long 1000 XYZ October 25 calls and short 50,000 shares of XYZ. Remember, the multiplier on options is 100, so the 1000 XYZ calls gives us the right (but not the obligation) to purchase 100,000 shares of XYZ at 25 through this Friday (October expiration).

Let's say that, as XYZ is trading at 25, the delta of the calls is .50. Quite simply this means that the calls are expected to move 50 cents per dollar move of the underlying. As XYZ stock rallies, the delta of the call increases and you become "longer." Look at it this way: If the stock rallies to 30, your 1000 calls will give you the right (but not the obligation) to purchase 100,000 shares at 25. As you're already short 50,000 shares, your NET position will be long 50,000. If the stock drops to 20, your calls will expire worthless and your NET position would be short 50,000. This is called "positive gamma" and it's a popular strategy among professionals. Sounds easy, right? Think again. Whenever playing "long vol," you must pay a premium for gamma---and with volatilities where they are (VIX 43), we're at levels that make this historically unattractive. Also, please be aware that I am sharing these strategies in an effort to shed light into the world of derivatives. Most individuals should NOT attempt to use option strategies unless their VERY familiar with the risks involved.

Rolling up the sleeves and getting ready to rumble. Yes, I am eating humble pie on the Raiders, but as I said last week, an 0-5 Rams team scared the heck out of me. They were a lot like last week's market...stretched like a rubber band and due for a hard snap back. For my part, I am digesting more than just our first loss of the season...I'm also digesting that slew of White Castle cheeseburgers that I swallowed at the Q-lounge. I'll tell ya, they always taste good going down-but you always pay for it in the days that follow. Analogies everywhere!

See you after the opening.
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