Delta vs. Gamma

Sometimes the second derivative has a bigger effect than the first.

I described a couple of weeks ago a short strangle combination position in FAZ that combined short July 16 puts, short July $18 calls (sold naked on the puts, and partially covered on the calls), along with a purely naked short of the same strikes for January.  Taken together with the long shares, it was delta neutral with the stock at $16.93 a share.

These combinations have the unique quality that they get “longer” as the stock price goes down, and”shorter” as the stock price goes up, so they are self-regulating for any stock that has a tendency to return to trend.

For example, now that FAZ has declined to around $15 a share, the total position measures as “long” 400 share equivalents, up from zero when the stock was $2 higher.

In spite of that, the position has gained in value over that time, albeit not as much as it would have it had entirely consisted of options, with no stock.

Today, the stock is up, but the position is down.  Both of the January options have gained in value, even though the puts have lost inherent value as the stock climbed.

Which brings us to the point of the post — that volatility is up enough to overcome the increase in value from being in the correct directional position (the positive delta).  Everything I’m gaining on the stock and the decline in inherent value of the puts is being given back in an increase in time premium.

FWIW, the increase in vol on this and on the puts on URE that I hold is quite a bit more than the CBOE’s general market vol trading instrument, the VIX.  It’s only up 2% as of the time of this post.

Be careful out there.  This extra volatility implied by both the puts and the calls in financials and real estate indices may be the lead for a broader market return of higher volatility.



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