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When a PUT moves against you.
Wednesday, June 7, 2017
DLTH - Duluth Holdings crashed today after bad earnings.
I generally sell the longest dated PUTs. In DLTH's case, PUTs only went till November.
Yesterday June 6, at 20.57
A high delta of 720:
A high delta is a double edged sword. If the stock goes up, the great. If the stock goes down, then it can be disastrous.
In this case, a pull back of nearly $4 in stock price means a value drop of $2,800.
It is always good to look at the loss potential first. "Can we handle that loss?" should be the question.
Did I ask that question? Yes, I did. Still, I did not expect a near $4 drop in a $20 stock.
Is a PUT spread worth it still? Absolutely. Without a doubt. Just understand your risk.
The PUTs today, at 16.7:
We have about 6 months to expiry. Keep it?
The issue here is the 35 PUT does not have any time value. So, it may get exercised. Which means I buy 1,600 shares at 16 * 100 * 35 = 56,000 .
I will then sell it at 16 * 16.75 * 100 = 26,800 . And sell the 20 PUTs at 16 * 4.2 * 100 = 6,720.
Since we already got cash for selling the PUT spread, the loss will be about the same as closing it today.
Just that your account will show a red flag in the AM and you need to close.
So, what did I do?
I bought back the 35 PUT and sold the 25 PUT.
So, now I am short 25-20 bullish PUT spread. *16.
The 25 PUT could get exercised as well, but less likely than 35.
I paid about $10 for this $10 difference, so the loss remains the same.
The delta math:
Delta is 720.
Loss as of yesterday: -1,285.
The stock pulled back -3.82 today.
So the loss should become: -1285 - (720*3.82) = -4035.4
So, now at 16.75, it looks like this:
The loss is at -4,085. Per our math above, the loss matches what the delta says. The math works. That part is good.
The delta is now 336. It is a shorter spread now, of 25-20 PUT. As the stock price goes down, delta goes down too. This makes the situation worse. When the stock pulls back, value goes down and delta goes down. So, much harder for the value to come back.
The max Gain was 501. We started doing this only recently, so a bit wrong. The max gain (on paper) was 1,800. At 28.8.
Max loss now: The value now is 1,120. It will go down to zero if it pulls back more. Can't help it.
Max gain: The value can move up to 2,400, if we buy back the spread at 3.5. If you think about it, we will be more skeptical about the stock even if it moves up. I hope not to sell bcos of that, but truly measure the risk at that time.
A loss is a loss. Part of the game. But, understanding the risk and exposure is really important.
This is how we went from a gain of 1,800 to a loss of -4,085. Happy that I did understand the exposure fully.