Long term options (LEAPS), should have a proportionately higher time value?

crgarcia · Sep 21, 2009

The longer the time, more chance something unexpected may happen (thus more volatility).

Besides, over a long time things may change so much that they become even more "unpredictable".
Although we just can't predict.

Thus LEAPS are underpriced, and short term options overpriced?

nazzdack · Sep 21, 2009

Quote from crgarcia:
.....LEAPS are underpriced, and short term options overpriced?

No and no. You have to take differences in implied volatility and liquidity into account too.

short&naked · Sep 21, 2009

Quote from nazzdack:

No and no. You have to take differences in implied volatility and liquidity into account too.

LEAPS do tend to be underpriced. However, as you mentioned, liquidity is a big issue. Even a LEAP on the SPY might have penny stock-like liquidity. Also, delta tends to be too low for a directional play.

dagnyt · Sep 22, 2009

Quote from crgarcia:

...Thus LEAPS are underpriced, and short term options overpriced?

Time decay is not linear.

Look at Black-Scholes equation and you will see that the time value of an options is related to the square root of time.

Thus, the time value in the price of an option is worth twice as much when the time to expiration is 4x as long.

Mark

ramaTrade · Sep 22, 2009

You can talk about what a options price should be all day long if you like, but just never forget the fact that options price is ultimately determined by supply/demand. In most cases, LEAPS are not as attractive as near term months, for one thing, the leverage factor is much smaller.

options4me · Sep 22, 2009

Quote from ramaTrade:

You can talk about what a options price should be all day long if you like, but just never forget the fact that options price is ultimately determined by supply/demand. In most cases, LEAPS are not as attractive as near term months, for one thing, the leverage factor is much smaller.

Also the LEAPS are good for a surrogate in place of actually buying the stock. (and for about 30% of the stock purchase cost).
Back in March I purchased some USO Jan 2011 15 call LEAPS to just hold on to during thru summer. Did a covered call aginst it once, then Sold them in July for a nice profit, without having to layout out the full stock price. Liquidity kinda sucks, but scalled out over couple days.

dagnyt · Sep 23, 2009

Quote from ramaTrade:

You can talk about what a options price should be all day long if you like, but just never forget the fact that options price is ultimately determined by supply/demand. In most cases, LEAPS are not as attractive as near term months, for one thing, the leverage factor is much smaller.

If you ignore what an option price 'should' be, you are doomed to failure.

I'm not talking about a situation is which there is extra/supply demand and an option gets out of line.

I'm referring to day in/day out buying and selling. If you overpay/undersell, you have no chance.

Mark

crgarcia · Sep 23, 2009

Quote from ramaTrade:

never forget the fact that options price is ultimately determined by supply/demand.

This is true.

In addition to the Black Scholes or Binomial mispricing, LEAPS are underpriced by the weak demand.

Most people buy options for short term trading.

Very few people (me included) buy long term options to reduce exposure -thus limiting risk-.