Stock price v. option price

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ericmoles

Hey there. I'm pretty new to options and some questions.

I want to use in the money equity options in order not to tie up as much capital as buying the stock.

If I decide a stock is going to do something, how do I know if I'm getting a fair deal on the option? Do you ever use market orders on options?

Once I'm in the trade, I'll want to base my exit on the stock price. Can I correlate a future stock price to an option price either for a stop loss or profit target and set my stop and limit order bracket on the actual option price? Or, should I set some kind of alert where when the stock hits value 'x' the system enters an order to sell the option at the market?

If I understand this correctly, it should work like this:

Stock is 100. At 100 I decide I want to go long and am expecting a 10 pt move. Profit target 110, stop 95. I buy a ITM call with a delta of .7 for 10.00 (I'm not sure if this price is anywhere near realistic, I just used it for easy numbers). Would I be expecting the call to appreciate to 17.00 and my stop to be 6.5?

Are there some markets where you can use market orders for your stop and not get slipped too bad and others where you would never dream of using a market order and would want to use a stop/limit order?

Thanks for the advice. Sorry if this doesn't make much sense. It is late.
 
As a rule, you shouldn't use market orders in your options trading. Maybe you can do it with SPY or QQQQ options but I don't recommend it. I'm trading ES/EW and DAX options, both are pretty good markets for options trading. Even so, maket orders don't works for these.

On the other hand, if you want place your limit order before stock price reach your goal you must take in to account your IV options prevision for that price. It's another added difficulty.

Remember that trading options is slightly different to trading futures or stocks. If you don't want to gamble the IV game you must wait for your moment and then place your limit order. On average you can shave a nickel off the bid/ask and fill a better trade accepting the IV at that moment.

Regards
 
Quote from ericmoles:



Stock is 100. At 100 I decide I want to go long and am expecting a 10 pt move. Profit target 110, stop 95. I buy a ITM call with a delta of .7 for 10.00 (I'm not sure if this price is anywhere near realistic, I just used it for easy numbers). Would I be expecting the call to appreciate to 17.00 and my stop to be 6.5?

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If you expected to buy the option and either hit your target or get stopped out all on the same day, then your scenario above might make sense. But since it's highly unlikely that would happen, the element of time seems to be missing from your analysis.

Are you taking into account the fact that if you hold your option for a little while, it could decline to your stop price even if the underlying stock didn't move or even rose a little? Or that after a few weeks' time decay, the stock could indeed rise $10 but the option wouldn't rise to $17?

You're also not taking into account the dimension of implied volatility. Even if your stock did rise to $110 the same day you bought the call, it's quite possible the implied volatility would fall and your call wouldn't reach $17 - although your long gammas would help counteract that.

In other words, you can't think of options in such a strictly linear way. You have to take into account the additional dimensions of theta (time) and vega (implied volatility).
 
Thanks guys. Sounds like I have a litlle more planning to do. I know time will decay my value, but I figured that the option would be fairly in the money and this would be less of an issue.

Maybe I'll start with one contract on a cheap stock and experiment. If my stock price gets hit, I'll have the system peg my order at the ask or the bid + a little.
 
Right, try it small and see how it goes. I'm not saying your approach can't work, just that you need to be aware of all the different ways options move other than in response to movement in the underlying.
 
Sure, paper trading will help you, but you need some theoretic basis for trading options.

The price of the underlying contract and the direction in which you expect the market to move, the amount of time remiaining to expiration, the volatility concept... you will be faced with several different factors that you must understand if you want trade options successfully.

You must work with a theorical pricing model and understand it too. Then you really will be able evaluate the market options pricing and determine how manage your trade.

Maybe it sounds too hard or bored but there isn't shortcut here.

Regards
 
You can spend a lot of time calculating possible option values and determing what the option will be worth at specific price and time intervals and then set P&L stops. Personally, I think it's not the best approach because it's the stock's move that is the primary concern.

For example, if I have a long position in XYZ (or its calls) and there's good news with a subsequent pop, I'm going to carefully monitor the movement and if I feel that the underlying is reversing, I'm going to either close the position or adjust it in order to lock in some of the profit. Having some arbitrary target is likely to cost me because it might not get there. Same holds true for a protective stop.

Now it might make sense to do this if you're unable to monitor your positions intraday but IMHO, if you can'tmonitor them, you shouldn't be trading them.

You can make this really complicated... or not.
 
if you're just wanting to use options to replicate long or short stock you might consider conversions and reversals. yes you'll give away some edge to the market and yes that involves two legs so your comish may be a bit more but you will capture the whole move in the stock for or against you. There are some other pitfalls but as mentioned already the time you're considering holding the position may come into play.

If you're trading in stocks whose options are listed on 4 or 5 or more exchanges are fairly liquid the spreads in the options are pretty tight and in a lot of cases may be 5 cents or less, especially for retail size.
 
Quote from ericmoles:

Hey there. I'm pretty new to options and some questions.

I want to use in the money equity options in order not to tie up as much capital as buying the stock.

If I decide a stock is going to do something, how do I know if I'm getting a fair deal on the option? Do you ever use market orders on options?


black scholes or vanilla option pricing from your broker or software. Try to use limit orders if you can, but if you are getting killed maybe use one to ge out in a liquid market.

Once I'm in the trade, I'll want to base my exit on the stock price. Can I correlate a future stock price to an option price either for a stop loss or profit target and set my stop and limit order bracket on the actual option price? Or, should I set some kind of alert where when the stock hits value 'x' the system enters an order to sell the option at the market?

either way stops and profit targets can vary alot depending on type of trading. Some guys will use 50% as an uncle point (emergency stop loss) on options.


If I understand this correctly, it should work like this:

Stock is 100. At 100 I decide I want to go long and am expecting a 10 pt move. Profit target 110, stop 95. I buy a ITM call with a delta of .7 for 10.00 (I'm not sure if this price is anywhere near realistic, I just used it for easy numbers). Would I be expecting the call to appreciate to 17.00 and my stop to be 6.5?

Are there some markets where you can use market orders for your stop and not get slipped too bad and others where you would never dream of using a market order and would want to use a stop/limit order?

yes the most liquid ones, some equities spy, iwm, xlf, etc. The less volume usually the wider the spread.

Thanks for the advice. Sorry if this doesn't make much sense. It is late.
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understand delta you should be able to calculate it in your position, graphing the position may help here.

http://www.thinkorswim.com/tos/displayPage.tos?webpage=lessonGreeks
 
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