New to Options, confused on the mechanics

S

sudoTrader

Hi, I have never traded before in my life and for the past few weeks I've been research stock options trying to learn as much as I can before I start investing real money. I understand all the basic concepts however am still fuzzy on stuff like exiting a position.

For example today(10/19) in my virtual account I bought 200 puts on QQQ on opening, at strike $67, at $.20 price. Same day the option went to $1.2 and I sold them netting me about (200x100x(1.2-.2)) $20,000 in profit.

However if I had instead exercised at the current price of $65.70 and bought/sold the share I would have netted (200x100x(67-.2-65.6)) $22000 in profit.

Is it normal to have made more money exercising first and then selling off the shares for profit or do most traders just sell the contracts as is? And for what reason is one way, better then the other?

If I did not have the funds to exercise then sell the stock am I still able too in something like a cash settlement?

At exactly what point does does my option become worthless or too hard to sell? Can I trade it at the last possible minute before the market closes on expiration day or do option traders normally try to exersice/sell it well in advance of expiration?

In the off chance that the stock moves against my position what are my exit strategies. Do I simply sell the contract again at whatever market value at a loss or let it expire worthless?

Help is appreciated :)
 
Do you have the $13.6M to buy 20,000 shares of GOOG ?? You're buying options to get leverage on smaller capital position, because you couldnt affort to buy the stock anyhow. You have to give up something to do that, and that cost goes to the writer.
 
Hi Sudo,

First of all, welcome to the world of options trading. It is a very dynamic field with lots to consider, to choose from as well as to gain and loose. It is good that you are paper trading.

First of, the point to option trading is to buy and sell contracts. Some do buy options so that they can exercise it and get the stock for a better price, but most option traders are in it for the quick movement, large leverage for your money, as well as not having to spend tons and buy the stock up front.

As far as timing goes, your options will loose money as you approach your option expiry date. So if you bought Nov 2012 options, then the closer you get, the more the price of the options decrease. You can find out the rate of decay of your price by studying and familiarizing yourself with option greeks. In this case, it is the Theta of the option. Google option greeks to find out more.

You also never want to wait till expiry date to sell your option, when you choose to get into an option, make sure you give yourself some time for the option to run up (or down, if you buy a put) to a resistance or support line on the stock that you are buying into. If I have a good idea that, say, Apple is going to move in a certain direction within the next few days, then I usually buy an option a couple months out. So if this is November, I buy the December Calls. That is my preference. It gives me some leeway in case Apple does not go the way I had intended and I have time for it to adjust to where I hope it might end up. Others may buy the front month (the closest month) and others may buy leaps, options that are 6 months to a few years out.

An exit strategy is essential. This is where you need to familiarize yourself with basic technical analysis. Basically, how to look at a stock chart and have a sense where the price will meet resistance on its way up, or support, on its way down. There are many stages that the stock price takes as it charts its route, experience will tell you an approximate time as to when it is best to exit. You also have to factor in your own trading style. Are you longer term or shorter term.

This is an exciting field and you are just on your way. Take your time and don't trade real money until you have more education. There are many factors to options trading and you need to have a good handle on them before you take the plunge. Good luck my friend!
 
Quote from sudoTrader:

Hi, I have never traded before in my life and for the past few weeks I've been research stock options trying to learn as much as I can before I start investing real money. I understand all the basic concepts however am still fuzzy on stuff like exiting a position.

For example today(10/19) in my virtual account I bought 200 puts on QQQ on opening, at strike $67, at $.20 price. Same day the option went to $1.2 and I sold them netting me about (200x100x(1.2-.2)) $20,000 in profit.

However if I had instead exercised at the current price of $65.70 and bought/sold the share I would have netted (200x100x(67-.2-65.6)) $22000 in profit.

Is it normal to have made more money exercising first and then selling off the shares for profit or do most traders just sell the contracts as is? And for what reason is one way, better then the other?

If I did not have the funds to exercise then sell the stock am I still able too in something like a cash settlement?

At exactly what point does does my option become worthless or too hard to sell? Can I trade it at the last possible minute before the market closes on expiration day or do option traders normally try to exersice/sell it well in advance of expiration?

In the off chance that the stock moves against my position what are my exit strategies. Do I simply sell the contract again at whatever market value at a loss or let it expire worthless?

Help is appreciated :)
More...

1. Your pnl is wrong. An option is never worth less than it's intrinsic value (exercising and unwinding the stock position). If the spot was 65.6, the option had to be worth a least 1.4

2. No. You cannot do cash settlement on a listed option that is physical settled. You cannot exceed your margin either (actually you can, but your broker will get mad at you and you might be subject to some kind of prohibition - I don't know).

3. Early exercising an option is somewhat involved for a newbie. You should do some reading. Practically speaking it makes little sense to early exercise an American put unless interest rates are high. You should only exercise a deep in the money call if there is an iminent dividend. Otherwise NEVER early exercise.

4. Understanding when options become worthless or when they become illiquid in a microstructure sense, etc is one of the key aspects of understanding options pricing.

If you want to learn to manage an options book, you should do some reading on the theory of options first. Then you can see how that theory applies to the market - you'll see that the theory is like 90% correct.
If you just want to punt around in options then you don't need to worry about doing this work and just remember: option value >= intrinsic value (except in some very very esoteric cases) and don't early exercise unless there's a dividend and your call has NO chance of ever being out of the money.
 
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