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Sunday, October 14, 2012

Using P&L Curve and Greeks together to Manage Time-selling Portfolio

I have spent some time stream-lining my thoughts on managing the monthly income, time-selling and delta neutral portfolio with the Greeks and the Profit and Loss Graph. This is the last post on this topic for now.

The P & L Graph is a very good tool to present the current and expiration P & L across different prices. Its expiration (red) curve demonstrates the potential P & L during expiration. This is not easy to figure out from the Greeks if the expiration has many days to come.

The Greeks are good at estimating the immediate term (1 day or 2) P & L only, since they change significantly with prices and volatility. The Greeks are closely related to the current P & L (white) curve. For high priced stocks (i.e. SPX, RUT), it is not easy to estimate their P & L directly using the Greeks, because the stocks may change $10 a day but the Greeks (delta) measure the change of $1 only. A series of calculations would have to be made to get an approximate estimate of the portfolio P & L changes when using Greeks.

Combining the expiration P & L curve with Greeks should make it easier to manage the portfolio. At the option inventory building phase, I make every attempt to build a monthly portfolio with smooth expiration profit curve. As market attacks the portfolio with disruptive price changes, I will watch the market price against the expiration P & L. If the price is near the break even points, I would make adjustments. When making adjustment, I will manage the Greeks to neutralize market disruptions and try to maintain a smooth expiration curve again. If the expiration graph is not available, the Greeks should alarm for potential risks. An increasing absolute value of delta signals the white curve moving away from the center of the expiation (red) curve.

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