Managing an options portfolio at expiration – Part IV

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Let’s reproduce the Table 3 again showing the payoffs at expiration.

Spot priceNet deltaDelta P&LPremiumNET P&L
19443,950-$46,385-$900-$47,285
19543,950-$2,435-$900-$3,335
196-16,050$41,515-$900$40,615
197-16,050$25,465-$900$24,565
198-6,050$9,415-$900$8,515
199-6,050$3,365-$900$2,465
2008,950-$2,685-$900-$3,585
200.38,9500-$900-$900
2018,950$6,265-$900$5,365
2028,950$15,215-$900$14,315
203-21,050-$5,835-$900-$6,735
20433,115-$26,885-$900-$27,785
20533,115$6,230-$900$5,330
20633,115$39,345-$900$38,445
So now we know what happens to our options portfolio at expiration if we do nothing other than exercise in-the-money options. How does this information help us manage risk? It can be useful to form an “if-then” type plan. For example, “If the underlying moves to here by this time, then I will sell some of the current deltas because I would be concerned about a retracement”. Or, “If the underlying moves down there, I make a profit and could buy some deltas to ‘lock this in’. But I’m concerned that if the spot continues to fall, then the 196 strike that I am short starts to loom on the horizon. Perhaps I could spend some of the profit made from the move down to $196/7  in order to buy back the 196 puts that I am short?”
These are common tactics. By knowing the payoff profile and the overall position delta at each different spot price, the trader can see ‘what he has to play with’ more clearly. He can also gauge the overall likelihood of risk being managed effectively. It is not uncommon for a trader to conduct an analysis like this and decide that the entire position is not something he is comfortable with relative to the cost of reducing or liquidating the position completely. This is common when the trader decides things are a little too binary; both the profits and the losses might be large, but the scope for something in between might be narrow.
Remember too that this is in some ways different to normal volatility trading, but in other ways not. Expiration is the time when options are ceasing to be options; in their dying moments, their value is only driven by short term sentiment and the market price; mathematical modelling has very little part to play. But volatility trading is still present, in so far as the option values must in some sense reflect the basic expectations of how much the spot price will move in the very near term.
Trading and risk-managing options at expiration requires a different skill-set and a complete understanding of the relationship between options and the underlying. Completing an analysis as we have in this series is a useful step in learning this procedure.

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