DELL Risk Reversal (Re-Post)

This morning I talked about putting on a new trade in DELL. The traded I decided to put on was a risk reversal. I sold the May $14 puts for $0.94 and bought the $15 calls for $1.27 for a net debit of $0.34 per spread. I have 10 of these and at the time DELL was trading at $14.85.

I chose this position over the synthetic as I believe that it offers me a bit more flexability to play different scenarios. So first lets take a look at the risk profile:






As you can see from the above risk profile that the options are pricing in a 60% chance that Dell will touch $16 by 2/18/09. Which is how long I intend to hold this position for, at least the call portion of the position. I also plotted what my breakeven point would be on this same day. You will notice that my break even is set at $15.34 and dell has a 81.5% chance of getting here. There are a lot of inputs that go into calculating this number so I will save you the explanation. But it has to do with all inputs that go into the option pricing model.

Next I want to disect each leg of the trade independently. So first lets look at the short puts. I like these as even if the call side of this position does not workout I am okay with selling the calls at a loss and holding the short puts to expiration. You can see below that these short puts have a 79% chance of expiring worthless by expiration. I like these odds. I also see support on the chart at the $14-$14.20 area. If this area were to be breached I would re-evaulate. But also notice that the break even for these puts is $13.07 well below where support is and well below where it is currently trading.




Next lets look at the long calls. You can see that the options market is pricing in a 75% chance that DELL hits $16 by expiration. I only need it to touch this level, then I will book the profit and manage the other half of the trade. Not that I intend to hold the portion of the position past 2/18/10 but I have a mathmatical edge as it stands now. Of course that can all change in a day.