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A Daredevil Trade In NovoCure: What To Do Now That You Are In-The-Money!

|Includes: NovoCure (NVCR)

On Monday, I wrote about an options trade in NovoCure Limited (NASDAQ:NVCR) that I borrowed from ex-market maker Jonathan Rose. He talked about it on Sunday on his latest episode of "The Week Ahead". I recommended buying straddles with expiration on March 18, 2016 and strongly advised doing it before the earnings announcement, which took place after the market close. The company's earnings press release was uneventful, although the stock did climb by a few percentage points on Tuesday. Either way, nothing that went outside the boundaries of the standard volatility took place (I calculated the standard deviation of daily returns to be just above 6%). This was before Wednesday:

(Source: Google Finance)

Today, the stock went up as high as 22%, going well above the $15 mark, before closing just below it. As you can imagine, my straddle became in-the-money, and I recorded a 50% gain at one point during the day (the straddle cost me $1.30 per contract, as you may recall, while its cost today peaked at $2.00 per contract) - not a bad return over a two-day waiting period!

I messaged Jonathan Rose asking him whether he thinks it is a good time to sell. You have to remember that time decay works for the seller, not for the buyer. If, by chance, the stock tanked the next day or hovered at the $15 level for the rest of its tenor, I would lose big time on the options' time value. He told me to hold on and to "scalp Gamma" instead.

Although "scalping Gamma" may sound like a very sophisticated strategy, I learned, partially due to Jonathan's explanations and webinars, that it is a very a simple thing. In fact, it is a lot simpler to "scalp Gamma" than "hedge Delta". When investors scalp Gamma, they simply sell the underlying short, if their calls are in-the-money, or buy the underlying, if their puts are making them money. This way, if the stock reverses the next day (in this case, tomorrow), you will not be left watching your paper profits vanish. Instead, you can either take profits on the entire position by selling/buying the exact amount of underlying corresponding to the size of the winning option leg (e.g. if you are long 10 calls, you should short 1000 shares to scalp Gamma. Recall that 1 options contract is equivalent to 100 shares) or partially monetize it (e.g. 40% - 50% of the position). In this case, if the stock keeps moving up, you will sell more stock short and lock your profits entirely.

If the stock starts dropping, you can sell more call options with a strike price at which the stock reversed the uptrend. This will be a good trade for two reasons:

  1. You will get good premiums as volatility will pick up and, hence, make the option more expensive;
  2. You will start making money on the puts (keep in mind that you have partially or fully locked your profits).

For more information on how to better manage winning trades watch this video lesson.

Of course, if you do not want to get into the "complicated" stuff I talked about earlier in the article, you can just sell you straddle at a nice profit. There is nothing wrong with that: taking money off the table never hurts. However, keep two things in mind:

  1. Sometimes it is not easy to sell option positions - volumes may be low and/or spreads may be very wide. In addition, transaction fees on options tend to be higher than, for example, on share transactions;
  2. You are leaving some money on the table by not exploring additional options you have with the straddle: if the stock is volatile, which is the case with NVCR (annual volatility of over 100%), you can make even more money on the trade, while it lasts.

What do you think? Have you been in similar situations?

Original article here: http://bit.ly/030316NVCR

Disclosure: I am/we are long NVCR.