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I see an interesting phenomenon and I don't know how to explain it.

I bought a long call option for 60000 USD dollars with the expiration date about 90 days later. At the time I bought this option, the underlying stock price was at 570 USD. However, the stock price dives about 10% and rebounds back to 570 USD about a week later. Then, I just see my option value is at 50000USD.

I assume that after a stock price rebounds, my option value will be the same. So, I don't know why this happened. Is this because the volatility of the option value? How do I avoid this problem? Buy a spread call? Thanks

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    gotta be honest, if you are putting 60k into options and don't know the answer to this question, please pull that money now and put it into index funds..
    – RAZ_Muh_Taz
    Commented Oct 19, 2020 at 16:48
  • I know expiration time and volatility are issues here. But I just feel they should be that significant.
    – Jerry Zhang
    Commented Oct 19, 2020 at 16:50
  • Also, I think index funds will have the same problem after the price rebounds
    – Jerry Zhang
    Commented Oct 19, 2020 at 16:52
  • Your numbers don't make sense to me. If the call costs $60k then the premium is $600. And yet the stock is only $570? Even with a VERY deep ITM call, that's hard to believe. Got details?
    – Bob Baerker
    Commented Oct 19, 2020 at 16:57
  • not at all, you put 60k into an index fund that costs 600 a share, that share gets a 10% drop your value goes to 54k, and then rebounds back, your overall will be back to 60k... What do you think happens?
    – RAZ_Muh_Taz
    Commented Oct 19, 2020 at 16:58

2 Answers 2

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The value of options depends on multiple factors. One variable that looks particularly relevant here is time.

In a period where the underlying stock goes through large swings, it is unlikely that volatility caused your option’s value to drop. The impact of time value, though, is a different story.

Imagine that the value of the underlying stock was constant throughout. You paid $60k at the start, but would you pay $60k on the day it expires? No, it would be just about worthless with zero volatility and no time remaining to maturity. What about halfway through the term? Perhaps $30k?

Options are like dripping taps. Unless the price or volatility etc of the underlying security changes, the (time) value of the option will steadily drop.

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  • I see your point. But do you think one week difference is really significant here? The expiration date is about 90 days away. So, I feel one week difference possibly does not really matter.
    – Jerry Zhang
    Commented Oct 19, 2020 at 16:48
  • If other people have similar stories, I am really interested in hearing your story.
    – Jerry Zhang
    Commented Oct 19, 2020 at 16:48
  • Option pricing is a tricky thing. Time-wise, 7/90 (days) is just under 8%. That’s almost halfway to your price drop of just over 16%. Another big factor is where market expectation lies. If the market doesn’t think the underlyer’s price will exceed $570 at option maturity (regardless of current pricing), that would exert downward pressure on call options as well, but that’s a lot harder for me to quantify.
    – Lawrence
    Commented Oct 19, 2020 at 16:59
  • The option is for stock Nvidia. So, it is very stable and I think it will finally get the 60000 dollars I paid.
    – Jerry Zhang
    Commented Oct 19, 2020 at 17:05
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    You should sell your options when they hit their highest value. Good luck figuring out where that is :>) . There is no simple answer as to when to sell your options since multiple variables have to be considered. In isolation, from a time decay perspective, 30 days to 45 days before expiration makes sense.
    – Bob Baerker
    Commented Oct 19, 2020 at 17:28
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The phenomenon is change in implied volatility coupled with seven days of time decay.

Before expected news announcements like an earnings release, IV rises, sometimes dramatically. This is also true with unexpected news, for example when it was announced that the president was taking Remesdevir. That caused REGN's IV to spike 10% and it has now dropped about 8%. Buying more expensive options at/near the peak option price after the spike would now have a loss due to some portion of 8% of IV contraction. Add that to the 7 days of time decays and the loss is explained.

If you want to isolate the IV component, look at options of a popular stock like AAPL or TSLA near the close the day before an earnings announcement and check them the next day. The loss in premium can sometimes be astounding.

Options spreads reduce the effect of IV contracting because you are selling some expensive premium which offsets the purchase of expensive premium. However, the strategy has entirely a different P&L.

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  • In a sense, time decay is part of IV, since the premium takes into account the total volatility over the entire term of the contract, and that's going to be larger the longer the time period is. The Black-Scholes model assumes that the volatility is constant, and so there's a simple decay as more and more of the total volatility passes. But in the real world, the volatility is variable.
    – Acccumulation
    Commented Oct 19, 2020 at 20:55
  • In practical terms, time decay is irrelevant in the very short term. And long term volatility over the entire term of the contract is also irrelevant in the very short term. The classic example is an earnings announcement where overnight, IV drops and even collapses in one to several days (see TSLA after an EA, down 10 to 30% and sometimes even more). Though not to that degree, it can happen in minutes, easily causing what the OP experienced.
    – Bob Baerker
    Commented Oct 19, 2020 at 21:08

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