Option Investor
Educational Article

How're Our Trades Doing\?

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I thought we'd take a look back at our theoretical trades from the last few weeks and see how they have progressed. Our put backspread trade on YHOO, the ratio put spread on AMAT, and our AMAT put skew example, can be seen in previous 101 articles from May 1st, 15th, and 29th.

On May 1st we executed our theoretical put backspread trade on YHOO as we thought there was a good chance for big downside movement. We purchased 2 Oct '01 $20 puts for $4.10 and sold 1 Oct '01 $35 put for $15.20, for a net credit of $700. Below is the YHOO option chain for today's intraday trading. We can see there really has been no movement in total option price changes with YHOO around $17.30/share. Our put backspread could be initiated today for about an initial $820 credit, so we are down about $1.20 on the trade so far. (Splitting bid/ask prices.)

If we look at the Imp Vol(B) and the Imp Vol(A) columns, we see that if we split the bids/asks, our spread will be initiated at a relatively flat skew. There's some interpolation involved here, but that's what the results yield. If we sell the $35 put at $17.60, that's roughly a 79-80% IV and if we buy 2 $20 puts for $4.70, that's roughly a 77.5% IV, giving us a very slight edge, volatility-wise.

We still have time left on this trade to mature, but as stated in the original article, we would want to exit this trade about 30 days before expiration because that's when time decay would start to really eat away at our long $20 puts. That would take us to about the third week of September before needing to take full action.

Let's see what our AMAT put ratio spread is doing. On May 15th, we bought 1 June '01 $50 put and sold 2 June '01 $45 puts for a small $.40 credit. Our position would profit if AMAT was trading anywhere above $39.60. Ideally we want AMAT to expire right at $45 for maximum results. As of today, 6/12/01, AMAT is trading for $54.50/share and it looks like we are in good shape. If AMAT finishes above $50 at expiration, all our puts will expire worthless and we'll keep our $.40 credit (Yeeha!). If AMAT starts ticking below $50, we'll start making $1 for every $1 down move by AMAT until we hit $39.60. The options expire this Friday. Here's the graph again.

If you are still uncomfortable with the 1 naked short $45 put, you can easily buy it back now for the minimal debit. Heck, you can even buy back both short $45 puts and end up with a naked long $50 put. If AMAT pre-warns before Friday and it tanks to $30/share for example, your long $50 put will be golden. (Remember, illustrative purposes only!)

Finally, our AMAT skew example from last week using the July '01 $40/$50 debit put spread. AMAT has risen about $1.25 since I last wrote and our debit put spread is now worth $2.15, giving us a loss of about $.60 Here's the updated option chain for today, 6/12/01:

If we had just bought the $50 put outright, we would be down $1 on the trade, so by initiating a put spread instead, we have kept our loss to a smaller amount so far. Plus, our breakeven on the spread requires AMAT to move a full $1 less to the downside. This is due to the fact that the spread cost us $2.75, whereas the $50 put could've been bought initially for $3.80, making the breakeven $1 farther away for the outright long $50 put. If you look at the IV columns, you will see that this debit put spread can still be done favorably on an IV basis. The $50 put can be bought for 64% IV and the $40 put can be sold for 73% IV. Even if AMAT doesn't move to the downside as you once predicted, you still know that you put the spread on at favorable prices. Last week's article illustrated this point by going through scenarios if we bought this spread at unfavorable IV skews.

I hope I haven't bored you with our spread and skew examples from the last few weeks, but I feel that these are the necessary steps to be taken before initiating any kind of option trade. There are many traders whose position life span may be only a few minutes long, and this kind of analysis would be worthless for them. I have a slightly longer time frame (weeks to months), and so doing all the research will help me put on trades with favorable conditions.

Until next time...

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