by **kennynah** » Mon Nov 02, 2009 6:49 pm

thanks BC for sharing your game plan....

in these instances, i agree with BC that it is not option trading per se... he is utilizing option as a complimentary tool to enhance his assets...via naked Short Puts and Covered Calls...

in a more stringent definition of option trading, it deals with trading the option GREEKS; such as profiting from trading theta, gamma scalping(a PhD concept: permanent head damage), vega, through strategies like conversions, boxes, iron condor, calender spreads, diagonal spreads, etc....

however, in BC's case, the Covered Call is actually the "traditional" concept of trading Theta...the decaying of option value as time passes.

but in the most stringent sense, if the option trader is focusing only on trading theta, he would have to be directional unbias. to achieve this, he must be delta neutral, which will require some form delta trading, either by altering stock or option quantity as the underlying price moves, so that the total delta of the position remains flat (or zero)... however, this is usually too expensive bcos of trade commissions... thus for retail traders, the calender spread is just about the closest form of Theta trading....

Example of Calender Spread

AAPL is now at $188.50

Short 18 days expiration $190 Call

Long 46 days expiration $190 Call

GREEKS of this Calender Spread

Delta : +3.22 (why do we have a +ve value? answer below)

Theta : 7.59

Gamma : -1.36

Vega : 16.93

Here, you see that Theta will give this trader a profit of $7.59 with every passing day, everything else excluded.

Delta is comparatively small, meaning that when AAPL rallies or sinks, the option value will not change much. This is especially so when the Gamma is also negligible...with every $1 change to AAPL, delta increases or decreases by a mere 1.36..when compared to the other GREEKS, both Delta and Gamma are smaller consideration for this Calender Spread...

a side note : in this calender spread, we are employing both the $190 Calls, but why then do we end up with a +ve Delta? Shouldn't a Nov expiring $190 Call and the Jan 2010 expiring $190 Call, both have the same Delta value? Obviously, the answer is NO... options with longer expiration date will ALWAYS have a higher Delta value, even if the options are of the same strike. The reason is simple, when i have a longer dated option, i have more chance of this option becoming In-The-Money as compared to an option that will expire sooner. Remember that Delta is loosely regarded as "chance of option expiring ITM"....

But note that Vega is where the risk is ... if Implied Volatility fluctuates 1% up or down, this position will either profit $16.93 or lose $16.93... thus, if AAPL's IV drops by 1%, this trader loses $16.93, which is not sufficiently compensated by the profit from Theta decay...

If this trader were to describe his position in option term, he will say " i am Long vega"... becos he wants Implied Volatility to increase, as that will profit his position... a 10% increase in IV for AAPL shares, he will profit $169.30...

In this example, the trader needs to manage the Vega...but how?

this is what i mean by trading GREEKS.... which includes managing risks presented by the GREEKS of any option position...

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