Question on Options Trading

B

ByLoSellHi

Basic question:

Without getting into delta, theta, etc., is there a price as a % of the share price of any particular equity that people here are not willing to pay more than?

For example, if the stock is $75, do you ever think that paying more than 6% ($4.50) is too high a price to pay to buy call options for several months on that stock?
 
Well it all depends. On a $75 stock you can buy a deep ITM call for maybe $40 to track the stock at a lower cost and risk. Some people have said that they would not buy a deep ITM call if it costs more than simply buying the stock on margin.

however with all strategies it is not the % of the stock price but the r/r profile that matters in relation to the stock. I would be interested in other's view of limiting the premium as a % of the stock price.
 
Quote from ByLoSellHi:

Basic question:

Without getting into delta, theta, etc., is there a price as a % of the share price of any particular equity that people here are not willing to pay more than?

For example, if the stock is $75, do you ever think that paying more than 6% ($4.50) is too high a price to pay to buy call options for several months on that stock?
More...
things to consider:

- what is your outlook on the stock?
- what is the IV now?
- what is the past IV behavior?
- are you ITM? ATM? OTM?
- what strategy you are using? directional? non-directional? Credit vs debit strategies?

One single price element is not sufficient to arrive at an investment decision.

with the new margin rule, you can be very creative in creating your own R/R design.
 
I don't get very complex either. If I think a stock will move X dollars over a given period of time, then I'll buy a Call only if the premium is less than 1/2 of what I think that stock can move.

The odds of a $75 stock moving $9 in a few months is not high for the majority of the stocks in that price range. Not in oil, not in materials.

Of course, any stock certainly COULD go up that amount, but given a recession possibility, with a timeline we cannot currently predict, and the fact that prices tend to reflect the reality RIGHT NOW, I don't think it's good odds and I wouldn't do it.

For calls and puts, a short time frame is better. Remember you are paying a time premium, so the farther out you buy a call, the more premium you pay... which has nothing to do with the stock price. This means that over time, your call has a time decay built in... a loss for the buyer, and a gain for the seller the longer you hold that call waiting for the payoff.

If it's going to take X months to take off... buying that call now simply reduces your profit, with expensive premiums, it's much cheaper to just buy the stock itself.

Also, IF we get another summer effect even close to as dramatic as last year's... and you are expecting a rise months out.... waiting that 2 or 3 months may get you a much cheaper stock or call anyway.

What stock are you talking about?
 
There's a way to be very scientific about buying options on stocks. "But," it is very simple:
Go to ivolatility.com and type in the stock symbol.
A volatility data page will appear.
Look at the current implied volatility and also compare that to the 52 week high and low implied volatility.
If the I.V. (implied volatility) is higher than the average of the 52 week high and low, I would avoid that stock and move on to something else (unless I was selling calls on it), because the option prices will be too high and you risk Volatility Implosion.
If the I.V. is average or lower, then go to the CBOE.com website.
From the home page, point your mouse at the words "Trading Tools." A drop menu will display the words "Volatility Optimizer," click on it and it will take you to the Volatility Optimizer page.
From this page click on "Option Calculator" and on this page type in the stock symbol and click "Go."
This will give you the fair value of the ATM front month call and put options.
You can adjust the expiration month on this page.
You can also adjust the Volatility, stock price and strike price.
You can simulate time versus price movement versus profit and loss.
For instance, a good example of buying slightly in the money calls on a $75 stock at extremely good price value is:
Stock....Price......Option.....Price
MMM.....76.71....May75C....2.90

MMM is at the lower end of its 52 week implied volatility range, which gives it a very reasonable option price for slightly ITM options. Entering MMM is the CBOE Option Calculator and adjusting the price to its current close at 76.91 and adjusting the Expiration Month to May, displays the exact call value the May75 call option closed at (2.90).
A perfect example of "fair value."


I hope this was helpful,

Jeff
 
Jeff, that was an extremely helpful link and explanation. That's exactly where I was going.

Everyone, this is a great discussion. I haven't been able to master my methodology of prudently buying options.

hels, you say buying near term strike price options is a good way to go, and I think that's wise in many cases, but interestingly, Guy Cohen in 'Options Made Easy' instructs buying call or put options that have an expiration date at least 6 months away, as a basic rule.
 
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