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Say for instance I have a view that MSFT in the coming 3 months is going to come out with a big upgrade to their full year guidance. Let's assume in the event that this happens the stock goes up a lot (+15%). Now suppose I want to buy a call option on MSFT to profit from this move.

How do I know what call option is likely to move the most if my prediction is correct? Liquidity considerations are important and clearly the time to expiry of the option is important (I wouldn't buy a 2 month option for instance) - but these aside - are there certain options which are likely to move more than others?

This is all hypothetical of course - and thanks all.

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The Captain Obvious answer is that the call with the highest delta will move up the most (price wise) if you prediction comes true. The not so obvious question is which option will have the largest ROI? In order to answer that, you have to make some pricing assumptions.

The first one is easy. The price target is 15% higher. Now it gets harder.

The timing is a little tougher. If this pending news is unknown (what insider told you about this ??? :->), why would you buy a call now when you can buy it closer to the news release, avoiding weeks or months of time decay? Will implied volatility start creeping up as the news release approaches (rumor leaks), causing you to pay more for your options?

What volatility input will you use for the later date? If there's going to be a quick 15% price spike in MSFT due to the news release, implied volatility will be higher then, briefly. In reality, it's all a guess so the most likely thing is to assume that IV will be unchanged and if higher, it will be gravy.

Once you've figured (guessed?) these assumptions out, the rest is easy. An option pricing model can be used to input all of these inputs and calculate the future value of an option 3+ months from now. That's a tedious, time consuming process. However, there are option software programs that will take all of your assumptions, calculate the future value of all of the options in the option chain and tell you which one would provide the highest ROI. The problem with this is that if your assumptions are incorrect, the ranking order of highest ROI options will be different, perhaps vastly different.

  • some interesting thoughts here @Bob Baerker. In terms of the Delta - this is what I thought - buy the option with the highest delta - yet insiders typically buy OTM options which happen to have low deltas? Is there something i'm not understanding here? You also mention implied volatility is important to understand. Intuitively, if the implied volatility of the option is high, this means the market may already be anticipating the move yes? Again, this is all hypothetical. I have no insider knowledge :) – Choco93 Nov 8 '19 at 8:52
  • The option with the highest delta will have the largest dollar gain but it will not have the highest ROI. For example, XYZ is $100. $80 call is $22 (100 delta and moves up $ for $) and $110 call is $2. Tomorrow the stock zooms to $115. $80 call is $25, up $13. $110 call is now $9, up $7. $80 call is clear winner. However, on an equi-dollar basis, you could have bought 11 of the $110 calls so for same dollar risk, profit for that would be +$77. Why do traders typically buy OTM options which happen to have low deltas? LEVERAGE (make $13 versus $77) if the long shot wins the race. – Bob Baerker Nov 8 '19 at 12:38
  • Yes, if implied volatility of the option is high, this means the market is anticipating a move. The prime example is an earnings announcement where good or bad news may lead to a large move in share price. Traders bid up option prices, causing IV to expand. Once the news is released and the players move on, IV contracts back toward normal levels unless it's ongoing news, perhaps something like a pending lawsuit of consequence where the outcome is unknown. – Bob Baerker Nov 8 '19 at 12:39
  • so if I understand you correctly, one way to make a lot of money (v high ROI) in options is to buy an OTM option (for the leverage) with a low implied volatility (expecting a move that nobody else is)? This obviously assumes you have some sort of view as to where the underlying might go - and you are also proved right (no mean feat I guess). – Choco93 Nov 8 '19 at 13:23
  • Yes, it's no mean feat so sign me up for your newsletter when you figure it out (see comment made in reply to you on the other question that you asked). Think of buying OTM leverage options as betting on the nags at the track (hope?). The odds against them are high because most of the time they lose. But when they infrequently win, they pay off big. And then there's the constant erosion of time decay... sigh. Try to find a better edge than hope. – Bob Baerker Nov 8 '19 at 13:30

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