# How do you go from a belief a stock will be a certain value to choosing a call option?

I'm familiar with stock trading and watching for market news and basic things like that. I have money I'm willing to lose to learn options trading.

I have some stocks with earnings reports coming up, and I believe that some of them will beat expectations and go up. If, for example, there's a stock trading for \$100 and I believe that it will be \$110 on Friday, how do I pick a call option to buy based on this?

There are two parts to the answer. For the first part, let's assume that there's no earnings announcement on the near term horizon. You can calculate the future value of any call that you buy using an option pricing model. That can be time consuming. A quick way to guesstimate the return is to look at the current option chain. Your premise is a short term \$10 up move.

If you buy a \$100 call with the stock at \$100, what would that call be if price rose \$10? Your call would be \$10 in-the-money. What call is \$10 ITM today? That would be the \$90 call. This guesstimation assumes that all option pricing parameters remain fixed other than price. If you bought a \$105 call, you'd take the price of today's \$95 call. Having done this, you can calculate how much each call would appreciate as well as what ROI each one would have.

For a much more accurate answer, you could set up an Excel spreadsheet with appropriate formulas and all you would have to do would be to input the prices of each call that you might consider.

Now, the second part and this is the big one. The implied volatility of options increases for weeks going into an earnings announcement and will contract shortly thereafter the release so this means that you are effectively overpaying for the option. There's a built in loss, sometimes sizable. That decreases your potential profit, reducing how much of the \$10 move you capture. You can offset some of that by selling some expensive premium (spreads?) but that's a more complex strategy and a different risk/reward spectrum.

You can also estimate any call's potential by looking at its delta but this is a very crude estimate because delta isn't linear.

And none of this has addressed what expiration to buy and the reasoning behind buying a nearer expiration or a further one. Nor did it account for some amount of time decay this week, as much as 3+ days if you buy your call(s) tomorrow.

The above just touches lightly on this decision making process.

I'd suggest that you read some option books to get a more in depth understanding. Don't attempt to learn option trading by wagering money that you're willing to lose in order to learn.

• do you have recommendation for good option books? (I'm in the same situation as the OP) Commented Feb 18, 2020 at 7:48
• AFAIC, the best book would be "Options as a Strategic Investment" by Lawrence G. McMillan. Well written with many clear examples. The first 1/3 of the book will give you a fundamental understanding of various strategies (buying options, covered calls and their synthetically equivalent short puts, spreads, etc). No need to spend \$75+ for the latest edition (1,000+ pages) since it involves more complex products and strategies which will most likely not be of interest to you or will take you years before being competent enough to utilize them. Older editions available for under \$10 online. Commented Feb 18, 2020 at 12:29
• "Option Volatility & Pricing: Advanced Trading Strategies and Techniques" by Sheldon Natenberg would be for someone who is interested in theoretical analysis of options rather than practical application. It leans toward more advanced trading strategies. Commented Feb 18, 2020 at 12:29