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Subject:  Re: Fool article - option spreads Date:  10/26/2006  7:45 PM
Author:  RaplhCramden Number:  7655 of 11356

The trade is EV neutral only at the instant you put it on. After a little time passes and time decay occurs, the trade becomes EV positive for the options seller.

If I sell you an option and I have your money, it seems my "expectation" in the financial sense must be that I must give you your money back at some time later PLUS the risk free rate of return as interest I pay you.

I believe what you mean to say is "after a little time, the EV becomes positive IF THE UNDERLYING STOCK PRICE STAYS FLAT." But of course the underlying stock price is not EXPECTED to stay flat, it is expected to rise. Indeed, every intuition in my body says it is expected to rise at exactly the rate that would keep the EV of your position tracking the risk free rate of return. So if you are net short, I would say the information in the options prices is that you EXPECT the stock price to follow a trajectory that has you effectively paying interest on your short position at the risk free rate of return.

As I write this I realize that each different strike price option will generate a somewhat different "implied stock price" over time. This is probably going to rise to the level where I'm going to need to think about it. It would seem you ARE buying DIFFERENT expected stock price trajectories with different options. I don't know what you would do with this.

So the only reason I am posting this at all is so I might remember it long enough to look into it.

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