In simple terms, once the put has moved into the money, you already have received the most bang for your buck; in the example above, the put options generated a 300% return on a 6% move in the XYZ common stock. But as the option moves deeper into the money, its price will begin to correlate on a dollar-for-dollar basis with the underlying shares. The reverse is true, too: As an option moves out of the money, its price falls less than the price of the underlying stock. In trading the stock against the option position, you are capturing the differential created by the slope of the delta, i.e., the rate of change of an options price relative to the change in price in the underlying common. With just one week remaining until expiration, if XYZ is trading at $50 per share, the puts will still retain an approximate value of 55 cents, which means if shares decline to $49.45, you can lock in that value through the purchase of stock and have the opportunity to make another risk-free trade. If shares move back up to $50, you have just scalped another $550 profit out of the position.
Cheap Retail Options
On Wednesday, with the Retail HOLDRs trading at $96, one can buy the December $95 put for $2 per contract. This gives the put option a break-even of $93, which represents the initial level one can buy stock to lock in a risk-free trade. But because the put currently has an intrinsic value of $1, one could probably safely begin scalping a portion of the position if the RTH dips to $94 per share. Some individual issues whose options have relatively low implied volatilities (based on their 52-week range) include Hibbett Sporting Goods ( HIBB), Coach ( COH), Kmart ( KMRT) and PetsMart ( PETM). These stocks have all had nice runs and are near 52-week highs or are approaching important resistance, which is the case with Hibbett as it fills the gap at $23 per share.