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You buy 50 shares, because in your proposed strategy you want to make money whether the stock goes up or down. Because the option strike price and underlying p
by leelin 11y ago
You buy 50 shares, because in your proposed strategy you want to make money whether the stock goes up or down. Because the option strike price and underlying price are the same, the appropriate ratio of underlying stock to options is about 50% if you want to be neutral to the future direction of the stock movement (delta-neutral as they say).
If you bought 100 shares with 100 covered, then you are purely betting the stock is going up by more than the option price. You would break even at $107, but lose on anything lower.
Implied volatility is the amount the stock is expected to move as implied by the price the market is charging. Sometimes it is easier to think of an option price in terms of volatility rather than raw dollars, especially when you are making trades of the type you proposed.
In the Netflix case, the current price of the option "implies" that the stock will move plus or minus 3% per trading day; if it moves more, say 5% a day, you are likely to make money.
Of course, thinking of options in this way also means you are on board with a ton of assumptions in modern options pricing theory, and lots of smart people point out flaws and objections.
- ZenoArrow 11y agoOkay, I understand about the 50 shares now, and the rest of your descriptions of how this work makes sense too, thank you for explaining this clearly. Going back to NFLX example, I have one more question. You said that NFLX was trading at $100 yesterday, so where does $7.00 a share come into play? Are the shares not $100 a piece?
- kasey_junk 11y ago$7 is the option price. The interest in your earlier example.
- ZenoArrow 11y agoAh, thanks kasey_junk. Okay, so I thought I knew enough to work the NFLX example, but I still came up with some mistakes. Unexpected values shown in blue here: http://oi61.tinypic.com/2h71ndh.jpg http://oi61.tinypic.com/2h71ndh.jpg I've probably made a fundamental error, what am I missing?
- kasey_junk 11y agoDon't execute on out of the money options. IE you eat the $700 in fees but you don't actually trade the underlying stocks they represent.
- ZenoArrow 11y agoOh, so you can just pay the fees, cancel the put option, and keep the stock you bought at the beginning of the process?
- kasey_junk 11y agoOr really sell the stock you bought at the beginning of the process if you want to take profit.
- ZenoArrow 11y agoYes, that's one option. So just so I understand, what flexibility do you have as the purchaser of the put option when it comes to selling. From what I understand the purchaser can choose to sell between the put option maturity date and the put option expiry date, is that correct? Are these typically the same date? Would you pay a premium to have a wider gap between the maturity date and expiration date?
- kasey_junk 11y agoThe major difference between OTC and exchange traded derivatives is that exchange traded ones have set contracts that standardize these things. What those set contracts are is exchange to exchange and product offering to product offering. You can take a look at CBOE's product web page to get an idea about the different kinds of options products they offer.