Minyan Mailbag: Trading Question
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.
I always really enjoy when you dissect your trades in terms I can understand (i.e. terms of a two year old!). I'd like to ask one other question about the methodology you employed in the UPS trade. As the stock price rises do you continue to put more stock out as a function of its delta? Also (so much for one question), assuming the stock fluctuates in price, are you covering as the stock decreases, as well, throughout the entire process? Thanks, John. Your knowledge and insight is always very illuminating for me. I hope this finds you and la familia well. Peace, my friend.
Not going into nuance, yes, as the stock price increases, the delta of the option does also until a point where the stock is far enough itm)">in the money where the delta has a maximum of 1 (the option price moves one for one with the stock price). If the stock falls, the delta will decrease, so we do buy the stock back, and re-sell it as the stock goes back up.
This implies that the more volatile the stock is (the more it goes up and down), the more money we can make as we are booking trading profits against the time premium we have paid for the options. If the stock is less volatile than what is implied in the amount of time premium we paid, we will lose money.
In this case we had several things work for us. The magnitude of the move up was large, if not overly volatile on the way up. So we did not make too much money on the way up, although some because the options were so cheap (didn't pay much time premium) and because they were cheap we were a little under-hedged on the way up (leaning delta long). Then when the options had a delta of 1, we were 100% hedged when the stock collapsed. Being 100% hedged is like being long the 80 strike put. When the stock collapsed we bought back our short stock and a significant discount to the loss on the option, which can only go to zero (and did).
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