Here's the setup: Long Aug 25 TOL Put @ 1.85 Short Aug 22.5 TOL Put @ .55 Net debit 1.3, breakeven @ 23.7 The stock is currently at 25.3. The long put will expire worthless if the underlying doesn't go down. Should I bail or do nothing until closer to expiration to get more time decay out of the short leg? Thanks!
If I understand correctly: this is a long bear PUT spread. The spread as a whole is OTM. From that, one can deduce the following with a basic knowledge of greeks (should serve as an illustration for why greek knowledge is not only beneficial but straightfoward): The spread will currently be short deltas. What does this mean? It means the spread wants TOL to sell-off in order to make money. Why is the spread short deltas? Because the long PUT has higher deltas (absolute value) being closer to the money than the further OTM short PUT. The net effect is that the long PUT wins out so the spread is overall short deltas. How do you remember this? Simple, options have higher deltas the further in the money they are. If they are really deep in the money then they will have deltas approaching 100 and behave like stock and vice versa. The spread will currently be long gamma. What does this mean? Simplistically, it means that the spread wants the underlying to move in the direction as shown by the deltas. Why is the spread long gamma? Because the long PUT has higher gamma than the further OTM short PUT. The net effect is that the long PUT wins out so the spread is overall long gamma. How do you remember this? Simple, think of a normal bell curve that represents the magnitude of gamma. ATM is where the curve has it's peak and far OTM and ITM are the tails of the curve. The spread will currently be short theta. What does this mean? It means that the spread's value is decaying day by day if TOL stays where it is. Why is the spread short theta? Because the long PUT has higher theta than the further OTM short PUT. The net effect is that the long PUT wins out so the spread is overall short theta. How do you remember this? Simple, it's the same as gamma but with a different sign i.e. long gamma = short theta and vice versa. So to answer your question: should you do nothing until closer to expiration to get more time decay out of the short leg? This supposition misses the fact that the loss incurred by decay of the long leg will outpace the gains incurred by decay of the short leg. That is why the spread is net short theta. Read off the theta value for your spread from whichever software you are using and that will tell you how much further $ is lost per day if TOL stays still. Use this value to help you decide whether you want to hold out for a move in your favor or not. Why is this so? Because gamma/theta peaks (is highest) for ATM options. The long PUT is closer to ATM than the short PUT and therefore has higher gamma/theta i.e. decays more than the further out PUT. Should you bail now? This is entirely dependent on what you think is going to happen to TOL and making that decision is what "trading" is all about. My advice: go decaf LOL. MoMoney.
MoMoney ... THANKS!!! Thank you for taking the time to post this. Sure enough, on the TOS analyse screen I see delta = -205.70 (short delta), gamma +34.13 (long gamma) and theta -3.81 (short theta). I think the Greeks are a lot simpler to understand than they seem at first, but when people toss around terms like these I was missing the intermediate steps to really understanding what they meant. (Of course, on only has to look at the P/L chart to see that TOL in currently at max loss, and needs to move down about $2.5 to hit max gain.) Now if you can explain "gamma scalping" ...
Hi Eliot.. I own TOL so follow it closely. You may already know this but they will be giving an earnings update the day after the Fed next week so if they disappoint you could be in the money...however if the Fed pauses AND TOL is fairly optimistic then you'll be done. FWIW the reason I'm long is unlike most builders TOL focuses on the high end which is less affected by higher rates and/or inflation.
No, I'm not in TOL, the OP was not me. I was just thanking MoMoney for the "Greeks for dummies" tutorial. BTW, around here (Sierra foothills) the RE market is pretty much dead, especially the high end.