9

I swing trade equity options every once in a while for fun. This morning I witnessed something I do not understand at all.

In the attached photo, why would someone purchase 6 contracts for .05 at $76. I just can't wrap my head around this!

Scenario:

  • Underlying Asset: RY.TSX
  • Current Price: $71.70
  • Days to expiry: 4 Days

Screenshot of Prices

EDIT: It happened again the next day with 74, see new table with headers as per request: Screenshot of Prices

My only reason for asking is because RY.TSX is the Royal Bank of Canada, this stock will not move multiple dollars in 3 days(expiry in this scenario). Why buy 10 @ 74 for .04 each instead of just buying 10 @73 for .04 which would have gone through.

If you do the math(excluding commissions):
.04 * 100(shares in a contract) * 10 contracts = $40
Stock moves to 74 and they are in the money lets say for .20
.20*100*10 = $200

I just don't see the reward as 99% of the time you will lose this wager, it is just not worth it even if it does happen once in a blue moon. I can think of much better things to do with $40. For the skeptics another screen shot to actually confirm this order: Screen Shot Purchase

  • Can we see the heading for this table? Are you sure you're reading this right? – Guy Sirton Mar 20 '14 at 1:21
  • @GuySirton Pictures added, I guess maybe the last scenario I'm missing is a possible super complex strategy with a bunch of buys and sells? – AM_Hawk Mar 20 '14 at 1:52
  • But in your second set of data it's 0.04 for 74, so the option is cheaper than the 73 option for 0.05. Still a bit odd, could be some sort of hedging strategy. Could be someone who doesn't know what they're doing... – Guy Sirton Mar 20 '14 at 2:36
  • 2
    Valid reasons to waste money on such worthless strikes could include a bear call spread, possibly a long condor or butterfly type trade. theoptionsguide.com/condor.aspx – Knuckle-Dragger Mar 20 '14 at 6:52
  • the spread trades answer is the right answer and most practical answer – CQM May 2 '14 at 22:57
13

I suggest you look at many stocks' price history, especially around earnings announcements. It's certainly a gamble. But an 8 to 10% move on a surprise earning announcement isn't unheard of. If you look at the current price, the strike price, and the return that you'd get for just exceeding the strike by one dollar, you'll find in some cases a 20 to 1 return.

A real gambler would research and find companies that have had many earnings surprises in the past and isolate the options that make the most sense that are due to expire just a few days after the earnings announcement. I don't recommend that anyone actually do this, just suggesting that I understand the strategy.

Edit - Apple announced earnings. And, today, in pre-market trading, over an 8% move. The $550 calls closed before the announcement, trading under $2.

enter image description here

  • I am familiar with this strategy and have actually used it once however earnings for RY are May 22nd and wouldn't you choose the $74 for the same cost(.05) leaving you deeper in the money at 76.++ ? – AM_Hawk Mar 18 '14 at 16:53
  • 1
    I understand. I did not know when earnings announcement would be. I was attempting to answer the question in a general way to explain why such a transaction might occur. For this particular stock I admit I have no idea why this transaction would make any sense. Perhaps inside information that something is going to happen? – JoeTaxpayer Mar 18 '14 at 16:55
  • I'm inclined to say typo...Thanks for the input, much appreciated! – AM_Hawk Mar 18 '14 at 16:58
  • 1
    If this was a stock like Enron, you could turn that small $76 investment into a few hundred thousand dollars by rolling far from the money options and having nerves of steel. Although you would want puts. – Pete B. Mar 18 '14 at 18:06
3

It could be that the contracts were bought at cheaper prices such as $.01 earlier in the day.

What you see there with the bid and ask is the CURRENT bid and CURRENT ask. The high ask price means there is no current liquidity, as someone is quoting a very high ask price just in case someone really wants to trade that price. But as you said, no one would buy this with a better price on a closer strike price. The volume likely occurred at a different price than listed on the current ask.

  • Thanks for the simple yet totally plausible scenario description! – AM_Hawk Mar 31 '16 at 17:15
1

Out of the money options often have the biggest changes in value, when the stock moves upward.

This person could also gain, by the implied (underlying) volatility of the stock rising if it moves erratically to either side.

Still seems to be a very risky game, given only 4 days to expiry.

1

The most likely explanation is that the calls are being bought as a part of a spread trade.

It doesn't have to be a super complex trade with a bunch of buys or sells. In fact, I bought a far out of the money option this morning in YHOO as a part of a simple vertical spread.

Like you said, it wouldn't make sense and wouldn't be worth it to buy that option by itself.

1

Perhaps it was to close a short position. Suppose the seller had written the calls at some time in the past and maybe made a buck or two off of them. By buying the calls now they can close out the position and go away on vacation, or at least have one less thing they have to pay attention to. If they were covered calls, perhaps the buyer wants to sell the underlying and in order to do so has to get out of the calls.

1

I think the best answer that doesn't make the buyer look like a moron is this.

Buyer had previously sold a covered call. They wanted to act on a different opportunity so they did a closing buy/write with a spread of a couple cents below asking for the stock, but it dipped a couple cents and the purchase of those options to close resolved at 4 cents due to lack of sellers.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.