The details of my Big Bet against Krispy Kreme

[KaneKungFu123]

what site did you use to purchase these options?

[DesertCat]

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what site did you use to purchase these options?

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My broker is Ameritrade, er. TD Waterhouse- Ameritrade or whatever they are called today.

[Maurader1]

Can someone explain the time value of an option to me? I know the option has intrinsic value, and time value, and therefore, the theoretical optimum exercise time of an American option is at expiry - the same as an European option. In this context, what does "optimum" actually mean? I mean, if my option is deep in the money, but not yet close to expiry, why should I hold it?

[Sniper]

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Can someone explain the time value of an option to me? I know the option has intrinsic value, and time value, and therefore, the theoretical optimum exercise time of an American option is at expiry - the same as an European option. In this context, what does "optimum" actually mean? I mean, if my option is deep in the money, but not yet close to expiry, why should I hold it?

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People hold deep ITM options as a proxy for the stock, that generally ties up less capital.

[KaneKungFu123]

"49 KKDQU ($7.50 May) bought at 35 cents, cost $1,715"

Can someone please show the math for Profit/Loss if at the expiration of this option the stock's price is at $7 and then at $8.

[KaneKungFu123]

Why couldnt you just short KKD?

[Groty]

"I mean, if my option is deep in the money, but not yet close to expiry, why should I hold it?"

The short answer is that the option's delta creates trading opportunites.

If your call option is deep in the money, you are better off protecting it's value by hedging the option (i.e., shorting stock against it). If the stock continues to run after establishing your hedge, then losses on your short stock position are offset by increases in the option value. You neither lose nor gain any money from the time you estabished your hedge (ignoring short rebate). At expiry, if the option is still way in the money, you just exercise and collapse the shares against your short.

Now consider the case where the the stock craps out after you've hedged your deep in the money call option. The loss in value on the option is offset by gains on your short stock position. Again, you neither lose nor gain. However, when the option delta gets really low, you will want to reduce or completely take off your hedge.

Now, you are in the happy position of owning an unhedged call option AND you have monetized the gain on your short position after the stock crapped out. If the stock runs again prior to expiry, you can do it all over again. It's like the gift that keeps on giving.

[DesertCat]

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Why couldnt you just short KKD?

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Unhedged short positions would expose me to infinite potential losses, while capping my maximum return at 100%. For example, assume I've shorted at $9. A kuwaiti decides to buy half the company in the open market, the stock price runs up to $25. A short squeeze ensues as other shorts cover their positions, and the price spikes at $109 before my broker buys in my shares. I now owe my broker $100 per share (1100%) on a short that I could never make more than $9 per share on.

Lastly, KKD is heavily shorted. I haven't tried, but I imagine it's difficult for your broker to locate "borrow", i.e. shares you can short. I've also heard that because the borrow is so tough, they charge you 25% a year to be short.

I never short unless it's a hedged. These put options cap my losses at 100%. They also provide me potential upside of 400-800%. Of course, since my options are currently OTM, I am risking a strong likelyhood of losing 100% when they expire OTM.

[schnoodleC]

The idea that unhedged short positions expose you to more risk than your options is completely wrong. The chance of your options being out of the money is pretty high. The chance of KKD more than doubling is non-existant. In addition most stocks don't double over night so there is always time to get out and you can always put in a stop cover. Unhedged option positions of significant size are always super high risk because the chance of losing your whole investment is high. What makes options lower risk is the fact that you can make smaller and more diversified investments since the return when your right is so high. As I've said before I think an option play on KKD is sound but the price of the puts make the strategy less appealing than you would think and again I think a position worth 5% of your portfolio is really playing with fire. Of course, I agree with your general idea and think you could come out big.

I would short KKD all day and night for up to 5% of my portfolio if I could get shares. In addition to there not being any available, I think there is some kind of restriction on shorting the shares now. I've tried hard and the message I get back from my (Fidelity) online account is strange. I think I might try again today and maybe call to see what the deal is.

Again, good luck...

[DesertCat]

If you put a stop on KKD to cover your short position, and it rises 10%, you get stopped out at a small loss. Yet the short position just got more attractively priced. I don't like selling when things get more attractive. So if I don't believe in stops, then I'm facing losses in excess of my investment. And I don't like paying interest to hold a position.

What would you do with your short if you get stopped out here? Just take the loss or re-establish? If you re-establish why stop loss in the first place?

And the odds of KKD doubling may be low, but far from non-existant. Esp. with the amount of shares shorted here, a short squeeze is very possible.

I would have less risk buying $7.50 or $10 puts for 07 and 08, but my upside would also be less. I chose to take the higher risk for a (potentially) higher reward. But for the shorter term options I probably should have bought $10 puts. Giving up some upside in order to limit the risk of expiring worthless seems like the smarter play since they are so short lived.