Trading Options on Goldman Sachs?

GS - Goldman Sachs

As I looked at GS chart, I cant resist wanting to go bearish on this stock.



GS is currently trading at $164.16 and has a current Historical Volatility of ~33%.

Using options, I can construct a bearish play, like so :

Long GS Dec09 165 Put and pay $5.60
Short GS Dec09 170/175 Call and receive $1.14

This position will cost a trader $446 and require a margin of $386.

The maximum losses is $946, if at option expiration, GS trades above $175; ie. GS goes past the Long 175Call option. If this happens, all of the premium paid, $446, for Long 165Put will be lost. The Short 170/175 Call spread will cost $500. Hence, the total damage = $946.

This position has unlimited profits. Although it is enticing to add a "unlimited" profit potential position, the trader must have a reasonable chance of it actually happening. In this case, we need to know how much GS price needs to weaken in order to make enough profits to justify the potential max loss of $946 !

To be able to achieve ~$950 of profits, GS must trade at $151 in 20 days time. GS must drop by some 8% from its current ~$164 price tag. Is this reasonable expectation? Let's get scientific about it.




Take a look at GS Option chain appended below. It shows that 150Put has a -0.14 delta. Ignore the -ve polarity. This is telling us that there's roughly 14% chance of GS price settling at or below $151 at expiration. Restating, GS has ~86% of staying above $151 in 20 trading days. Delta is a trader's rough gauge of an option expiring In-The-Money.

A more scientific way is to actually calculate the de-annualized Implied Volatility. Right now, averaged ATM option is showing about 31% annual IV. To calculate the potential move of GS price in 20 days, do this :

square root (20/365) x 31% = +/- 7%

There's a 68% chance of GS price fluctuating 7% up or down within 20 days. This makes GS price having a 2/3 chance of trading between $152.60 and $175.65. Now, this position makes ~$950 if GS price trades at $151 at expiration day. This calculation suggests that this is outside the 2/3 chance; ie. this trader has only 1/3 chance of making $950 or more but yet has 2/3 chance of losing $946.

Now, it is apparent that the risk/reward is not so enticing anymore.

Thus, as much as this trader likes to establish a bearish position on GS using options, current option chains do not offer the trader any meaningful way of doing so. It would be wise to find another trade.