Here’s some thoughts and insights that I want to share with you when it comes to trading singles and one of the big issues that people have.
When you’re trading a single option contract; let’s just take a look at Tesla, a lot of people are looking to buy some of these option contracts because they’re assuming the stocks might go up.
Now you might do it 49 days or 30 days out but I’d say the average maybe 30 days.
We’ll go a little bit out kind of around a 30 delta.
We’ll buy a single option.
I’ll show you why this is not a smart way to think about it unless you can offset the risk.
So there’s a couple of problems, the first big problem that you have is really the theta risk.
You’re going to lose 59 every single day from the theta or time decay.
Here I am with the 815 strike a call one contract and I’ve got about 36 shares and that’s what the 36 delta means.
So as it goes up a dollar I make 36 if it goes down a dollar I lose 36.
The big issue though as you look into this with a 30 plus day option when you look at your biggest greek, your biggest greek actually is not the theta nor the delta nor gamma but it’s the vega.
So this is actually the biggest problem so even though as this stock continues to head higher you assume you’ll be making money.
The white line is today and the green line is the expiration.
Note here the days and when you look at this as this continues to go higher you lose theta but not only theta you actually will lose vega because as stocks go up the volatility goes down.
You actually need volatility to go up because from options you make money from price, time and vega.
In this case if we’ve got a positive vega and I’m going up I’m actually going to be losing money because when vega goes down I will lose from the vega perspective.
When vega goes up i actually make money from the vega perspective.
The way to look at this is go to the gear icon on the lower right, this is the ThinkorSwim platform, you can look at the volatility adjustment area and what you’ll do is either increase or decrease vega.
In our case as the stock goes up there’s a couple of factors that we need to do number one it looks like we made a profit but it may take a few days to do that.
That’s why we’ll go into the time factor and increase the time a few days.
Instead of 400 we’re down to about 126 dollars and then the other thing that we need to do is we need to adjust the volatility so as stock prices go up the vega or volatility actually goes down.
So I need to reduce the volatility so what I’ll do is I’ll put a negative and I could start going down with my arrow keys and what you’ll notice is I’m losing money so as I’m starting to go down you could see if it goes down about three volatility points that’s three times 80.
I’m losing about 240 dollars just from the vega perspective.
Now I made some back from the delta and I lost some from the theta.
If we don’t take any of the date things into account, let’s say we nullify the date and price and now as price just heads higher volatility decreases.
So in fact I’m losing money so it’s a lot less than what most people think and this is the big issue.
When people are trading single options they don’t get that when they’re dealing with these option contracts there’s three main things that make up the value of this option.
Price risk, time risk and volatility risk.
Now together this comes up with your final value of the option contract and you can make money on price, time or volatility.
These are your risks but they’re also your moneymakers.
If you’re looking at your option contract and your biggest greek is your vega then you need to take that into account.
If you’re buying a single call option I’ve got a call that vega actually will work against me and that’s a big issue.
If I’m doing it on the put side it’s actually a little bit different and on the put side it actually works in my favor because as I buy a put and stock prices head down the vega will actually help me.
I still lose on the theta but I make it back with some delta.
The good thing is with a positive vega this is actually much more favorable it helps that vega helps me but the big problem is as it heads up against me.
I kind of lose money faster if it goes against me in this type of strategy when I’m trading a single put or buying a single put.
