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Stocks & Options: Finding Synergies


Creating hedged positions to minimize specific market risks.

I recently discussed 5 of "the Greeks" that are used to measure the risk of an option position. From the standpoint of risk management, trading stocks is far simpler than trading options. Stocks have delta (100 shares = 100 delta), but none of the other risk characteristics associated with options.

That suggests that it's far easier to trade stocks. All you have to worry about is whether the stock is rising or falling. In terms of the Greeks, risk is measured in terms of delta. If you own 300 shares, then you're long 300 delta. If the stock moves 2 points higher, you earn $600. That's the real number. There are no other risk factors at play.

When you're 300 delta long with an option position, and the stock moves higher by 2 points, it's not likely you'll earn exactly $600. Other factors -- the other Greeks, that is -- are also in play. It's possible to earn far more than $600 when you own positive gamma. It's also possible that you have a position with large negative gamma, and by the time the stock moves 2 points higher, that gamma has turned your total delta negative. In that case, you may lose money, despite beginning with a long position.

Thus, you may conclude that trading stocks is easier. But that's being shortsighted.
The fact that option pricing is dependent on a bunch of risk factors may make it seem to be more complicated to trade, but you have so many more powerful methods for managing risk. And that's what investing is all about: risk management. When trading, your goal should be to stay in the game and not incur large losses. You can accomplish that by fine-tuning positions so they make money when the stock undergoes a large move (long gamma), or when the stock trades in a narrow range (negative gamma, positive theta). You can prosper when the market becomes much more volatile (positive gamma and positive vega) or when it becomes dull (positive theta, negative vega).

Options are exciting. They can be combined with stocks to create hedged (reduced risk) positions that are exposed to (or protected from) specific market risks. You cannot do that when trading stock without options.
No positions in stocks mentioned.

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