Wednesday, February 15, 2006

Earnings Before Expiration

If you are positioned with short ATM gamma and there is an event right before expiration you have to make a choice to either keep it and expect options to go out worthless or incur a loss (hopefully limited by a spread).

We had to make such a choice with CLF. The 90/85 put spread is trading at about $100 and we're short a full position. Our risk is $500 per spread with a potential gain of $100 (actually it is less since we entered it a while ago with the stock being much higher).

What does one do in this situation?

Since our current focus is on risk management (as opposed to trying to rake in more premium) we had to make the correct decision to liquidate the position. We did keep a few long 85 puts just in case CLF disappoints but other than that we felt that giving back the $100 premium was more strategically sound than expecting CLF to do nothing.

What went into this consideration?

Well, one can start looking at the earnings history and see how the stock reacted to suprises or disappointments. One can look at implied vol and deduce a potential movement after the announcement. One can...

Hogwash. The stock can and will do anything it wants. Our only consideration was to give back a "known" $100 per spread today rather than look at a potential $500 loss tomorrow - exactly when we wouldn't be able to do anything about it in terms of hedging (this consideration would have been different had the annoucement been at an earlier date).

I've woken up to blowups before - the hard ones came on the third Friday of the month. And they stink! They stink because we know better and they stink for our performance.

And that's why we're flat.



At 2:51 PM, Anonymous Rick J said...

I have been following a site now for almost 2 years and I have found it to be both reliable and profitable. They post daily and their stock trades have been beating
the indexes easily.

Take a look at



Post a Comment

<< Home