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The "Greeks"

The "Greeks" are measures designed to better understand how option prices change when the underlying stock changes in value and/or time passes by (and options decline in value).

My goal is to keep this discussion of Greek measures as simple as possible. It is not easy. I have tried many times to explain these terms to people in person. I have seen their eyes glaze over before I get past Alpha.

I'm sure you heard about the fellow who bragged that he could speak every language except Greek, and when asked to say something in a particular foreign language, answered "It's all Greek to me." Let's hope that isn't your answer next time you are asked about a Greek stock option measure.

I'll confine this discussion to three measures of market risk exposure - delta, gamma, and theta. Mathematicians gave these measures the names of Greek letters, or names that sound like they're Greek letters (vega, another measure which we will not discuss here, is not in the Greek alphabet, but sounds like it should be).

Delta, gamma,and theta are the three most important Greeks in the world of stock options, and each tells us something important about an option. If you own 100 shares of a company's stock, your market risk is easy to understand. If the stock rises (or falls) by $1.00, you gain (or lose) $100. It's not so simple with stock options. The most common way to measure market risk for an option is the Greek called delta.

Delta is the amount the option will change in value if the stock goes up by $1.00. If an option carries a delta of 70, and the stock goes up by $1.00, the price of the option will rise by $.70 ($70 since each option is worth 100 shares).

Owning an option which has a delta of 70 means that you own the equivalent of 70 shares of the company's stock.

All options do not have the same delta value. Deep in-the-money options have very high delta values (perhaps in the 90s), while way out-of-the-money options have very low delta values (could be under 10).

To make matters more confusing, delta values change over the life of the option, even if the price of the stock remains unchanged. An in-the-money option, which might have a delta value of 60 with a month to go until expiration, will have a delta value of essentially 100 on expiration Friday.

You can calculate the net delta value of your composite option positions by multiplying the delta value of your long options by the number of those options and subtracting the delta value of your short options multiplied by the number of those options. The resulting figure, net delta value, tells you how much the value of your current option portfolio will change if the underlying stock goes up by $1.00. It is perhaps the best measure of market risk at any given moment.

Most professional market makers who hold a variety of options in their account, some long, some short, some puts and some calls, calculate their net delta value continually throughout the day so that they don't expose themselves to more risk than their comfort level allows. Ideally, they like to be net delta neutral, which means that with their current configuration of option holdings, they do not care whether the market goes up or down.

Gamma is a measure of how much delta changes with a dollar change in the price of the stock. Just as with deltas, all gammas are different for different options. While you may establish a net delta neutral position (i.e., you don't care if the stock goes up or down), the gamma will most always move you away from delta neutrality as soon as the underlying stock changes in value.

If there is a lot of time left in an option (such as a LEAP), the gamma tends to be quite stable (i.e., low). This holds true for both in-the-money and out-of-the-money options. Short-term options, on the other hand, have widely fluctuating gammas, especially when the strike price of the option is very close to the stock price.

A perfectly neutral option strategy would have a zero net delta position and a zero net gamma position. As long as you deal with calendar spreads, you will never enjoy this luxury. You will always see your net delta position fall as the stock price rises, and watch your net delta position rise as the stock price falls. Gamma measures tend to do the same, which serves to accelerate the change in the net delta position of a calendar spread portfolio.

Occasionally checking out the net gamma position lets you know how big the change in your net delta position will be if the stock moves up or down in price. It helps you know how your exposure to market risk will change as the stock price changes.

Theta is my favorite Greek, because it tells me how much money I will make today if the price of the stock stays flat when I have my favorite positions (calendar spreads) in place. Theta is the amount of daily decay. It is expressed as a negative number if you own an option (that is how much your option will decay in value in one day).

On the other hand, if you are short an option, theta is a positive number which shows how much you will earn while the option you sold to someone else goes down in value in one day.

Theta tells you how many dollars you will make today if the stock stays flat. For me, knowing this number has some negative implications, however. If I'm at a restaurant on a night when the market didn't change much, I might remember the theta value that day - it was sort of "free" money I really didn't make any effort to earn. Oftentimes, I order a too expensive bottle of wine because of that silly theta number).

The ultimate goal of my favorite calendar spread strategy (which I call the 10K Strategy) is to maximize the net theta position in your account without letting the net delta value get so high or low that you will lose a lot of money if the stock moves against you.

This short discussion of the Greeks should be all you need to impress your friends next time you talk about the stock market. All you need to do is to get around to the topic of stock options, and drop a few Greek names on them (ask them if they know what their net delta position was yesterday, or did their theta increase much last week, and watch their eyes glaze over).

I have found that the Greeks are very effective conversation stoppers. Feel free to use them whenever the need arises.

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Terry's Tips Stock Options Trading Blog

September 20, 2021

A Salesforce to be Reckoned With


As
its ticker symbol implies, Salesforce.com (CRM) provides cloud solutions for
customer relationship management needs. CRM reported earnings in late August
that blew away expectations on both the top and bottom lines. The report was
met by the usual round of target price increases that reached as high as $340
(CRM closed at $260 on Friday).





The
stock gapped higher after the report and extended as much as 5.5% higher the
next day, eventually closing with a 2.5% gain. But the shares then sagged,
joining the rest of the market in the early-September swoon. In fact, CRM fell
more than 8% from its post-earnings high.





But the shares appeared to find a bottom last week, thanks to the support of the 50-day moving average. Since turning higher in May, the 50-day has supported pullbacks in July and August. CRM has been stepping higher since a low in early March, putting in a series of higher highs and lows in a rally that has covered nearly 30%. This trade is relying on this trendline support holding for the next six weeks, as the short 250 put of our credit spread is just below the 50-day.









If you agree that CRM will stay above the 50-day moving
average (blue line in chart), consider the following trade that relies on the
stock remaining above 250 (red line in chart) through expiration in six weeks.





Buy to Open CRM 29Oct 245 put
(CRM211029P245)

Sell to Open CRM 29Oct 250 put (CRM211029P250) for a credit
of $1.10 (selling a vertical)





This credit is $0.02 less
than the mid-point of the option spread
when CRM was trading at $260. Unless the stock rallies quickly from here, you
should be able to get close to this amount. Your commission on this trade will
be only $1.30 per spread.  Each spread
would then yield $108.70. This trade reduces your buying power by $500 and makes
your net investment $391.30 ($500 – $108.70). 
If CRM closes above $250 on October 29, both options will expire worthless and your return on the spread would
be 27% ($108.70 / $391.30).


September 13, 2021

Going Once, Going Twice … Sold on CPRT


Going Once, Going Twice … Sold on CPRT





Copart (CPRT) provides online auction and vehicle remarketing services in the U.S. and several other countries. On Wednesday, the company reported Q4 earnings that easily beat on the top and bottom lines. Used car prices are soaring and CPRT is positioned perfectly to leverage the market. Analysts seem to agree, as CPRT received several target price increases that ranged up to $165 (CPRT closed at $143 on Friday). Despite the positive news, the stock fell as much as 5% on Thursday before closing 2% lower. However, CPRT gained more than a percent on Friday amid a down market.









The stock has been in rally mode since late March, gaining more than 30%. The 50-day moving average has been instrumental in guiding the uptrend, containing pullbacks in May, June and August. The trendline appears to be doing its job again, as it supported this week’s post-earnings drop. This trade is relying on this support holding for the next five weeks as the short 140 put of our credit spread is just below the 50-day.





If
you agree that CPRT will stay above the 50-day moving average (red line in
chart), consider the following trade that relies on the stock remaining above
140 (blue line in chart) through expiration in five weeks.





Buy
to Open CPRT 15Oct 135 put (CPRT211015P135)

Sell to Open CPRT 15Oct
140 put (CPRT211015P140) for a credit of $1.20 (selling a vertical)





This
credit is $0.05 less than the mid-point
of the option spread when CPRT was trading at $143. Unless the stock rallies
quickly from here, you should be able to get close to this amount.





Your
commission on this trade will be only $1.30 per spread.  Each spread would then yield $118.70. This
trade reduces your buying power by $500 and makes your net investment $381.30
($500 – $118.70).  If CPRT closes above
$140 on October 15, both options will expire worthless
and your return on the spread would be 31% ($118.70 / $381.30).


August 31, 2021

Get INTU This Trade


Software
developer (QuickBooks, TurboTax) Intuit (INTU) reported earnings on Aug. 24
that handily beat estimates on all fronts. Earnings came in at $1.97 per share,
topping the analyst forecast by 24%, while quarterly revenue of $2.56 billion
beat the estimate by 10%. The company also raised its quarterly and annual
revenue and earnings guidance above expectations. To top it off, INTU raised
its dividend and approved a new $2 billion repurchase authorization.





The
Street clearly loved the report, as the stock was hit with several large target
price increases (one raised the price 27%). The average new target price after
these raises was around the $640 mark, which is 13% above INTU’s closing price
on Friday.





The stock price took the news and target increases in stride, though, with no change on Thursday after the report. On Friday, the stock resumed its huge rally with a 2.4% gain. INTU is up nearly 50% in 2021, with most of that gain coming in the past 3-1/2 months. The shares have been riding along their 20-day moving average, a trendline that has not allowed one daily close below it since mid-May. The 20-day is currently at 541 but should cross above the 550 level in less than two weeks at its current pace. This is also the site of the short put strike of our credit spread.









If
you agree that INTU will continue its rally along the 20-day moving average,
consider the following trade that relies on the stock remaining above 550
through expiration in seven weeks.





Buy
to Open INTU 15Oct 540 put (INTU211015P540)

Sell to Open INTU 15Oct
550 put (INTU211015P550) for a credit of $2.80 (selling a vertical)





This
credit is $0.05 less than the mid-point
of the option spread when INTU was trading at $566. Unless the stock rallies
quickly from here, you should be able to get close to this amount.





Your
commission on this trade will be only $1.30 per spread.  Each spread would then yield $278.70. This
trade reduces your buying power by $1,000 and makes your net investment $721.30
($1000 – $278.70).  If INTU closes above
$550 on October 15, both options will expire worthless
and your return on the spread would be 39% ($278.70 / $721.30).


Making 36%

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