options

Discussion in 'Options' started by kcnewtrader, Jan 26, 2010.

  1. ive took a course on options and it talked about deltas and stuff like that but the part it didnt explain is how i know when i have a profit or not. if i bought a call and the stock went up how do i know when ive made a profit or not. And the premium that I pay for the option is that lost when i buy the option or does it go to the value of the option so do i gain a profit for each dollar the stock goes up with in the money calls or does it have to go up the amount of the premium to make up for what was already lost before I gain any kind of profit at all.
     
  2. MTE

    MTE

    It's the same as with stocks. You buy something at one price (in case of options it is the premium you pay) and then you compare it to the current market price to determine your open P/L.

    The above applies prior to expiration. At expiration the option is either worth zero or the difference between the stock price and the strike price. So at expiration in order for you to make a profit the stock price needs to be above the strike price for calls (below the strike for puts) by the amount of the premium you paid.
     
  3. I see so the stock has to jump quite a bit in a short amount of time to really make a profit then since it has to cover the price of the premium as well.
     
  4. MTE

    MTE

    It's not that straightforward as the relationship is a bit more complex. However, to generalize, the longer you hold the option the more the stock has to move to counter the time decay effect.

    For example, if you buy an at-the-money call option with 1 month to expiration today and tomorrow the stock moves up then you would make more money compared to the money you would make if the stock makes the same-sized move 2 weeks from now.
     
  5. I know that at the money and out of the money options have more time value which decays over time. But if im understanding what your saying i have to make atleast the amount of the premium to make any profit at all and even more then that to make up for any time decay.
     
  6. MTE

    MTE

    Think of it this way. Prior to expiration you can buy/sell your option at the market price so your P/L will be determined by that price. As the stock goes up/down the option prices will change according to the relative impacts of delta (stock price change), theta (time to expiration) and vega (volatility).

    At expiration the option is worth either zero (expires worthless) or its intrinsic value (strike price minus spot price for calls, and vice versa for puts).
     
  7. It just seems to me like its alot harder to make a profit in options then in stock yes you make more when you make a profit cause its 100 dollars for each dollar the stock changes but still if you have to wait till it makes enough to cover the premium and the time decay it sounds like it takes a rather large jump in the stock in order to make a profit from the stock where as a stock profits from any change in the price in the direction ur beting for.
     
  8. Go to this web site and register for free. Then pick any stock of your choice and look at the last month's closing quotes for any strike that amuses you (look for HISTORICAL PRICES in their menu). Study the daily relationship b/t the stock's price and the option's price. A number is worth a 1,000 words :)

    http://www.crimsonmind.com/options/HistoryData.aspx


    If you don't want to register, I think they provide the last 5 days of quotes.
     
  9. where as you can profit by just a couple of dollars move in a stock but on an option it seems it has to move up several dollars to cover the price of the options premium and the decay so ya you might might 100 dollars for every dollar change in the stock once it hits a certain price but still that stock might have to move 5 or 10 dollars or more to cover the premium price before any profit can be made
     
  10. MTE

    MTE

    Based on your replies I see that you still lack the basic understadning of options so I suggest you visit some educational sites such as Options Industry Council.

    You do not need to cover the option's premium to make money. Here's one last try from me.

    You buy an at-the-money call option for $5.00. The same day the stock goes up $3.00. Assuming that the volatility hasn't changed, the option price will be around $6.50. So you can then sell it for $6.50 and you have a profit of $1.50.

    And here's where that $1.50 came from. An at-the-money call option has a delta of roughly 0.5, which means that for each $1 rise in the stock price the price of an option will rise by $0.50. So since the stock moved up $3, the option gained $1.50.

    This is just a simplified example to demonstrate the principle. In reality the option's price and therefore your profit/loss is also affected by time decay, volatility, bid/ask spread and other factors.

    P.S.: I sure hope that was a free options course as otherwise it obviously was a waste of your money since it talked about delta, but at the same time, you lack the understanding of the basic concepts.
     
    #10     Jan 26, 2010