netwrangler
05-02-2008, 04:56 PM
In the chat room this morning, xxOz posted the following message:
Hi Net, earlier I mentioned an Option play that people thought you could give some insight on. Was thinking of a Vertical Spread on ESLR for Sept. Buy the 10s and sell the 12.50s. Any opinion?
I asked for 30-minutes and fired up the Hoadley Option Strategy Analyzer in Excel.
Here were the prices of the options and the stock at the time of the analysis:
Stock PPS = 8.59
SEP 10 CALL
-- Premium Spread = .95 x 1.05
-- Implied Volatility = 69.7%
-- Delta = .47
SEP 12.50 CALL
-- Premium Spread = .45 x .55
-- Implied Volatility = 66.0%
-- Delta = .26
To keep the math simple, I used 10 contracts [for each option] as the size of the position and also assumed no brokerage fees.
The initial position is then established by
-- buying 10 SEP 10 CALLS @ 1.05
and
--- selling 10 SEP 12.50 CALLS @ .45
for a net cost of $600.
There are two ways to look at the potential results:
=====
Value at Expiry:
If the PPS = $10 or less, you lose $600
If the PPS = $10.60, you break even
If the PPS = $12.50 or more, you gain $1900
NOTE: You can estimate the value of the position at expiry for PPS values greater than $10 and less that $12.50 with the following formula:
Value = (PPS - $10.00) * 1000 - $600
using a PPS of $11 as an example
Value = ($11.00 - $10.00) * 1000 - $600
Value = $1.00 * 1000 - $600
Value = $400
=====
Value During The Life of the Options
At the time the position is opened, the difference in the Deltas of the two options is (.47 - .26) or .21. This indicates that for every $1.00 increase in the PPS, the value of the position goes up (.21 times 100shares/contract times 10 contracts) or $210.
NOTE: Figuring exactly what your 'net take home' is gets tricky here.
Let's assume the price goes up $1.00 that very day [not a likely assumption, but one that makes the example easier to follow].
The base calculation is that you sell out your position for the $600 you paid plus the $210 increase in value [due to the price increase].
Of course, out of that $210, you have to cover the spread and pay any fees. Even so, it's fairly straight-forward to see that you can close your position prior to expiry at a profit if the PPS increases enough.
But what if that PPS increase of $1 comes through in 30-days?
Well, you lost some time-value on the position. The intrinsic-values have changed because the PPS has changed. In all likelihood, the volatilities and the spreads have changed as well...and this resets all the 'Greeks'. Time to take another run through Hoadley's tools
IMO, putting a stock trader into an option trading environment is a little like taking a .22 rifle target shooter, giving him a shotgun, and saying, "Let's go hunt some doves!"
When the target shooter finally recognizes the doves as his targets, he reaction is, "Stay still, dammit!"
Another factor to consider is that the PPS, and thus the value of the position, can go down. It really pays to figure stop-loss levels ahead of time. If you don't want to lose more than 25%, then get out while the position is still worth $450.
As a practical matter, however, you will do better to configure your stop-loss levels as alerts, rather than market orders. This will protect against selling out because of random some pricing anomaly.
=====
So, is this vertical bull spread a good trade?
That depends on where you think the PPS is going.
Will it increase 15% in the next 30 days?
Will it increase 50% by next September?
Well, then, maybe this is a good deal.
If those increases seem a little higher than you think likely, then look for another way to play the increase, or pass altogether.
Finally, there are all kinds of option-based positions and trades. In my experience, it makes sense to choose a couple of trading strategies and learn how they work over time. Do simulated trading first. There should be no rush to take advantage of some 'fantastic opportunity'. Take you time, and you will be dollars ahead in the long run.
Hi Net, earlier I mentioned an Option play that people thought you could give some insight on. Was thinking of a Vertical Spread on ESLR for Sept. Buy the 10s and sell the 12.50s. Any opinion?
I asked for 30-minutes and fired up the Hoadley Option Strategy Analyzer in Excel.
Here were the prices of the options and the stock at the time of the analysis:
Stock PPS = 8.59
SEP 10 CALL
-- Premium Spread = .95 x 1.05
-- Implied Volatility = 69.7%
-- Delta = .47
SEP 12.50 CALL
-- Premium Spread = .45 x .55
-- Implied Volatility = 66.0%
-- Delta = .26
To keep the math simple, I used 10 contracts [for each option] as the size of the position and also assumed no brokerage fees.
The initial position is then established by
-- buying 10 SEP 10 CALLS @ 1.05
and
--- selling 10 SEP 12.50 CALLS @ .45
for a net cost of $600.
There are two ways to look at the potential results:
=====
Value at Expiry:
If the PPS = $10 or less, you lose $600
If the PPS = $10.60, you break even
If the PPS = $12.50 or more, you gain $1900
NOTE: You can estimate the value of the position at expiry for PPS values greater than $10 and less that $12.50 with the following formula:
Value = (PPS - $10.00) * 1000 - $600
using a PPS of $11 as an example
Value = ($11.00 - $10.00) * 1000 - $600
Value = $1.00 * 1000 - $600
Value = $400
=====
Value During The Life of the Options
At the time the position is opened, the difference in the Deltas of the two options is (.47 - .26) or .21. This indicates that for every $1.00 increase in the PPS, the value of the position goes up (.21 times 100shares/contract times 10 contracts) or $210.
NOTE: Figuring exactly what your 'net take home' is gets tricky here.
Let's assume the price goes up $1.00 that very day [not a likely assumption, but one that makes the example easier to follow].
The base calculation is that you sell out your position for the $600 you paid plus the $210 increase in value [due to the price increase].
Of course, out of that $210, you have to cover the spread and pay any fees. Even so, it's fairly straight-forward to see that you can close your position prior to expiry at a profit if the PPS increases enough.
But what if that PPS increase of $1 comes through in 30-days?
Well, you lost some time-value on the position. The intrinsic-values have changed because the PPS has changed. In all likelihood, the volatilities and the spreads have changed as well...and this resets all the 'Greeks'. Time to take another run through Hoadley's tools
IMO, putting a stock trader into an option trading environment is a little like taking a .22 rifle target shooter, giving him a shotgun, and saying, "Let's go hunt some doves!"
When the target shooter finally recognizes the doves as his targets, he reaction is, "Stay still, dammit!"
Another factor to consider is that the PPS, and thus the value of the position, can go down. It really pays to figure stop-loss levels ahead of time. If you don't want to lose more than 25%, then get out while the position is still worth $450.
As a practical matter, however, you will do better to configure your stop-loss levels as alerts, rather than market orders. This will protect against selling out because of random some pricing anomaly.
=====
So, is this vertical bull spread a good trade?
That depends on where you think the PPS is going.
Will it increase 15% in the next 30 days?
Will it increase 50% by next September?
Well, then, maybe this is a good deal.
If those increases seem a little higher than you think likely, then look for another way to play the increase, or pass altogether.
Finally, there are all kinds of option-based positions and trades. In my experience, it makes sense to choose a couple of trading strategies and learn how they work over time. Do simulated trading first. There should be no rush to take advantage of some 'fantastic opportunity'. Take you time, and you will be dollars ahead in the long run.