Fusion Investment Fund sold 5 FDX June $90 Puts (FDXRR) at $4.00 on May 22nd. The analysis behind the FDX position was explained on the 21st May.

Fedex closed June 3 at $89.94, the puts last traded at $2.70. My favourite options quote provider, The OIC, shows

As those values are the primary options values and Greeks I’ll mention, let’s quickly recap what they mean.

It’s All Greek To Me

• Bid/ask mean is the average if the current price option traders are prepared to buy (bid) and sell (ask) at. I always use limit orders for options and generally place the sell limit for short term options at around the mid point of the spread or higher. For longer term options I often start with a sell limit above the current ask and adjust as condition warrant.
• Open interest tells you the total number of option contracts that are currently open, doh! I’ll explain open contracts in a second. The important thing to know is open interest is a sign of liquidity, and liquidity in general reduces the spread between bid and ask, so you can get better prices. Now back to open interest. When you place an option trade it is either an opening or closing transaction. You are either opening a new position or closing an existing position. When I entered my FDX order I selected Sell to Open (see the image). Did my trade increase the open interest? I have no idea. Whether a trade increases open interest or not depends on both parties to the trade. If both parties are opening then open interest increases. If one is opening and the other closing there is no change to open interest. If both are closing then open interest in decreased.

• Option value is the option’s theoretical price as determined by the Black-Scholes option model using underlying instruments statistical volatility. I compare the theoretical price with the actual price to see if traders are anticipating increased volatility.
• Implied volatility is the market’s estimate of future volatility and is derived from the option’s last traded price. I use IV in conjunction with option value. In general high IV means fear is rampant as it is a good tell to sell, while low IV implies greed is dominate and it is a good time to buy long term options. At the bottom of the OIC options quote page you’ll see historical and implied volatility including 52 week high and lows. It is important to compare the current IV with historical highs and lows.
• Delta is the change in the price of an option for a small change in the price of the underlying stock. It tells option traders how fast the price of the option will change as the underlying stock/future moves.
• Gamma is the rate of change of the delta for a small change in the price of the underlying asset. It is important because it shows how fast delta will change as the market price of the underlying asset changes.
• Theta shows how much value the option price will lose for every day that passes.
• Vega is the rate of change of the options value with respect to the 1% change in the volatility.

An Example

Let’s use my FDX naked Put for some clarification.

• As you’d expect with a large cap stock there is plenty of open interest. The option value is higher than the theoretical value and the IV is near the 52 week high. This confirms I received a good price and will have no problem with liquidity.
• With 13 trading days to expiration I’m not particularly interested in the delta. At -0.4889 I note that I have around $3 of safety in the underlying. If all else remains the same and FDX falls $1 tomorrow then the option price will be $2.675+0.4889 = $3.15
• With a Theta of around -0.07 with everything else remaining the same then time decay eats 7 cents a day. If all else remained the same and FDX closed at the same price tomorrow then the options would be worth $2.675 – 0.07 = $2.60
• Vega of 0.1269 shows this option is sensitive to moves in the volatility of FDX. Generally Vega is more sensitive with at the money options. As the IV is still high on FDX the price of options has a lot of opportunity to fall due to decreasing volatility. Which is good for me.

Position Conclusion

The trade is working out as planned and there is no need for adjustments. Since I entered my trade Warren Buffett has said that he believe the US may enter a long deep recession. A long deep recession would be the worst case scenario for FDX. As my working thesis is that the US is already in a recession I will continue to monitor this position, but in all likelihood will hold the position to expiration.

Do the Greeks accurately predict the future?

FDX closed up 1.61 (+1.79%) Wednesday. The 90 Puts bid/ask mean is 2.025 (1.95-2.10) and last trade was 2.00 down .70.
Using the Greeks let’s check to see if what was theoretically meant to happen did transpire.
The delta was -0.4889. Multiply 1.61*-0.4889 = 0.79. Another day has passed so time decay, theta, should have eaten another 7cents for a total of $0.87, yet the bid/ask mean only decreased $0.65 and the last trade $0.70. Where has my 20 cents gone?
First let’s look at the theoretical value which currently stands at 1.5702 and yesterday was 2.3335 for a change of $0.76. Which is closer to my calculation.

The difference between what yesterdays Greeks implied the price should be and the actual option price, is due to change. The Greeks are not static. As the underlying asset price changes so do the Greeks and the option price accordingly.

The Greek most responsible for dealing with change is Gamma.

As discussed yesterday Gamma shows how fast delta will change as the market price of the underlying asset changes. Gamma was 0.0602, multiply that by the price change of 1.16 and we get 0.0969. Subtract that from yesterday’s delta and we get a new delta of -0.3920. The reason that is not exactly the same as the closing delta of -0.3961 is that the Greeks are constantly changing throughout the day to reflect the changes in the underlying. In this case Gamma changed from 0.0602 to 0.0559.
If we take the closing delta and re-run our first calculation. Multiply 1.61*-0.3961 = 0.64. The result is closer to the theoretical change. Add in the 0.07 time decay and the result is close to the actual change of $0.70.

Theta has increased from -0.0703 to -0.0756. So as expected the closer we get to expiration the faster the time decay. Excellent! That’s what we want as option sellers. Volatility has also changed, but I think we have covered enough.

I haven’t yet included not understanding the Greeks in my 10 Biggest Mistakes in Option Trading series, but as in any endeavour you will do better if you know the tools available to you. I hope this quick overview has helped make the Greeks clearer.

Related posts:

1. Day Three: Ten of the Biggest Mistakes in Option Trading
2. Day Two: Ten of the Biggest Mistakes in Option Trading
3. Fusion Options Analysis
4. Day Seven: Ten of the Biggest Mistakes in Option Trading
5. LEAPS and Option Cycles