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Option Writer Update

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Goldman Sachs (GS) is up over $8 at about $175 per share. The earnings are due on June 17th which is next Tuesday prior to the market's open. The trade setup is to write the out of the money puts and calls on the front month options. In the example, we are selling 5 contracts of each. The strategy is to take adavange of the increased Implied Volatility ahead of the corporate event, in this case the EPS announcement. As the picture below shows the June Implied Volatility (Shown at the right on the Monthly Expration row) is about 61.50 The July Implied Volatility (IV) is about 50 or 11.50 points lower. The front month IV usually declines to be in line with the other expirations. For instance, October is at 46. So the June IV could drop 15 points to around 46.

Note that the initial margn is at about $11,600. This is a larger position than or normal trade. However, this post is for informational purposes only. Just under the left heading "PRICE SLICES" the Delta is slightly positive at 31.79. That means that the position should theoretically profit $31.66 per each $1 move up. But we are looking for the position to profit a different component than direction. The Vega shows the theoretical profit per 1 point change in IV. If IV declines 11 points, the position should theoretically profit $763 (69.40 X 11).

The white curved line is the estimated profit/loss line on June 17th with an assumed 11 volatility points subtracted from the position. The vertical lines at 166.45 and 190.86 show the approximate breakeven levels. As you can see the difference between the current price and the downside breakeven level is closer to the upside breakeven. If we want to give the downside room we can either sell the June 160 Put strike and/or sell the June 185 Call strike. This strategy can be optimized for the individual trader's risk tolerance and directional bias. If the stock stays flat, and it won't, the Profit is estimated at $1,300. That is an 11% return for two days with a defined range to at least break even. However, the unknown is how much the stock can gap and which direction. The return goal is to generate an average of 10% with a breakeven range of at least that much. The outside vertical lines at 159.46 and 194.90 show the down and up 10%, respectively. Let's monitor this hypothetical trade with a followup lesson on Tuesday morning.

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