5 Q&A from the Sept. 25th Options Trading for Beginners
Q: If I want to sell before the option expires, can I choose when and does the writer have to buy it back? – John
A: You can choose to sell your option at any time prior to expiration. When you sell that option, though, it isn’t necessarily matched back up with the original seller. In other words, you don’t have to trade with the same person as the original trade. The buys and sells are pooled and matched through the exchange. As long as there is ANY buyer out there, you can sell your option.
Q: Explain again the relation of the stock price, strike price and the intrinsic value. – Bruce
A: For the call option, the stock price minus the strike price is the intrinsic value. For the put option, the strike price minus the stock price is the intrinsic value.
Q: What are your personal opinions on the down side to call options? Any? – Avi
A: It depends on how you use it. If you’re buying a call in place of buying the stock, one down side is that you have an expiration on the call option. As such, there is time decay – or a drop in the value – as you get closer to the expiration date. Also, just like buying a stock, you have the risk associated with a drop in the stock price. If the stock price falls, the value of the call option falls. However, there are benefits that can’t be forgotten. These include more leverage and greater choices in managing the trade.
Q: If you sell the option before the expiration, do you sell at the stock price or the option price? – Geoff
A: You don’t sell at the stock price – you sell for the current option premium. Remember, you paid a premium to buy the option. That premium is based on the intrinsic value and the time value. When you sell the option later, there will likely be a new premium based on current intrinsic + time value. If you bought a call option and the stock price goes up, you would have more intrinsic value.
Q: Is the premium price per contract or share? – Don
A: Options chains list the price per share for an option. Therefore, a quote of $3.55 for a particular option would cost you $355 for each contract you buy (plus commission).
Q: Why would you sell a call at a loss, rather than letting it just expire? – Jill
A: If you let an option expire worthless, you lose the entire premium. If the trade starts to move against you, it is better to sell the option at a loss since you still have some value in the premium. That’s the objective of risk management – don’t give up the entire trade, but rather salvage your capital when you realize you’re wrong.
Q: I’ve heard that the potential for gain is greater with options trading than with just trading stocks. Is there truth to that and what makes options gains more lucrative, compared to trading common stock? – Ben
A: There are two reasons why options can be more profitable than stocks. The first is leverage. You can control the same stock for much less capital. For example, you may be able to trade a $100 stock for a $40 option premium and still get almost the same profit. An eighty cent profit on $40 is better than a $1 profit on $100. Second, options give you more flexibility. You can make money if the stock moves sideways – something you can’t do with the stock. We teach these strategies through The Options Oracle every week!
Q: I just took your Options for Beginners webinar today. I wanted to say thank you, it was a good presentation. I also took your intro to trading webinar on Tuesday. Exciting!!! If you had a short position that wasn’t doing very well, could you buy an option with a strike price below your entry level for the short and then immediately turn around and exercise it to cover the short? (And thus make a profit…)? – Tim
A: Think about the two parts of the trade. First, you have a short trade that is losing money because the stock price rose. Second, you buy a low strike call but you pay a premium for both intrinsic value and time value. If you exercise, you would realize intrinsic value but you would immediately lose time value. So the answer is “No” – you would actually lose more money in the scenario you described!
5 Responses to “Q&A from the Sept. 25th Options Trading for Beginners”
Volatility:
I was watching CNBC and an analyist was on there using some volatility measure. He predicted moves of 400 points either way and his insight has been right over the last week or so. What is this volatility measure and how can I use it?
Aj, Rick
Could you please give an example of placing a Trailing$ stop on an option order?
Since you don’t know what the price swing is for the option at the time the underlying is on its way up or down, what is a good figure to place in the stop. $1.00, 0.50, 0.75 or something greater?
You can place a trailing stop on an option order by linking it to either the option price or the stock price. The beter choice is to link it to the stock price. Find your stock support level and set the initial stop just below support. You would do this with a conditional order type – A) if the stock price hits “x”, B) then sell the option. We prefer to manually manage the option trade since we can often get price improvement by trading between the option spread.
Volatility is often measured through the CBOE Volatility Index, or VIX. You can learn more about that here: http://www.cboe.com/micro/vix/introduction.aspx
Oh my god enjoyed reading this blogpost. I submitted your feed to my blogreader!!
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