Personal Finance & Money Stack Exchange is a question and answer site for people who want to be financially literate. It only takes a minute to sign up.
Sign up to join this community
I'm new to options trading so if this question does not make sense or is stupidly easy please bear with me. I'll try to show my thought process through an example.
XYZ is currently trading at $100. I buy a deep out-of-the-money contract of XYZ at a strike price of $120 for $.06 (.06*100) = $6, with 3 weeks until expiration. If XYZ shoots up to $115 the next week, will I be able to "sell" my contract back for a profit (say premium is now $.12)? Or can I not sell an OTM contract until it is ITM?
I put in the details of your scenario. I adjusted the volatility to get the price near what you showed.
Next, I dropped the time to 2 weeks. Look what happened -
The stock, still out of the money, but the call jumped to $1.39. If the stock doesn't keep rising, the price of the calls drops each day and expires worthless. But there's a chance to sell at a nice gain. 20X your money is nothing to sneeze at. Congrats, if this ever happens to you. (And sell half, before you lose it all. I know)
I'll add a real life example -
This trade was entered a year ago. It's a spread. The cost was $3.52/sh with a maximum return of $30/sh. You can see the price is still not in the money, but the stock has moved enough that the spread price has widened to $9.30. A near $6K profit so far.
(Disclaimer - I've been trading options a long time, and have a handful of losers as well. This is a cherry-picked example to answer your specific scenario, a profitable option trade for strikes that are not in the money)
Sure you can sell the call before it is in the money. Now, you do have to be aware that its very incertain that you will be able to recoup your investment or make a profit.
You need to understand that as you near the expiration date of an OTM option, it becomes less and less likely that it will become ITM during its remaining life. Consequently, the price of that option is not likely to go up enough to offset your initial bet.
Also, just to be sure you understand, this is a wildly speculative strategy.
The short answer is that you can sell your call any time you want between now and expiration (I should probably stop here :->)
Understanding what the call's price will be across time and price involves understanding the gamma and the delta of an option. Since that's higher up the food chain let's try a numerical example instead of a technical explanation.
The delta of an option is how much the option will change per point of change in the stock XYZ and for a call, it will increase as share price increases. Delta is non linear. The more the stock rises, the more that delta increases. Delta is also a loose approximation of the probability of the option being ITM at expiration. The delta of the call in your example is about 2 which means that the call will appreciate 2 cents for the first dollar XYZ rises (if it happens immediately) and has about a 2 percent chance of being at $120 at expiration. Not very good odds.
Let's consider three scenarios.
(1) XYZ rises $10 immediately after you buy the call. For the first $1 of rise, your call will increase by 2 cents. For each additional dollar that XYZ rises, the call will increase by 2-1/2 cents, then 3, 4, 5, 6-1/2, 8, 9-1/2, 12, 14-1/2 cents. After a $10 move in the stock, your call might have risen a total of 67 cents (these are theoretical values).
(2) XYZ moves up $10 but it occurs 10 days from now. The initial delta will be about 1 and will increase 1,1, 1, 1-1/2, 2, 2-1/2, 3, 4, 5, and then 6-1/2 cents. Now, you only made 26 cents on a $10 rise.
(3) XYZ rises $10 but it doesn't occur until the day before expiration (20 days from now). Delta is zero and it will still be zero with XYZ at $110. The call's price will likely be zero.
While a call purchase like this isn't as bad as a lottery ticket, in the world of options, it's the same thing.
Here's an image of a graph of delta from an image search.
can I .. sell an OTM contract until it is [not] ITM?
Yes. You can sell the option at any point prior to expiration, assuming someone is willing to buy it.
Market makers are obligated to quote $5.00 wide, so worst case, you end up selling it for $5.00 less than it is worth. You can get an idea about how liquid the security is by the quantities on the bid and offer and the difference between the two. Market Makers not usually obliged to quote every single series (just a significant percentage such as 75% or 90%, which is helped by there being multiple market makers), though if you find there is no quote, you can ask the exchange to ask a market maker to quote that particular series.
It does not usually make financial sense to exercise the option if it is out-of-the-money. Similarly, if you have sold (or "written") an option that you didn't already have, you can be 'assigned' if someone exercises it. It can still happen if the option is out-of-the-money, but it is not very common.
Many options are still priced in $0.05 cent increments - so you may find that your order doesn't get filled if you offer it for sale at $0.12 - it may be displayed at $0.15 until you drop the price to $0.10.
Yes, you can.
I use this plotting calculator to get a feeling how my stock options strategy would fare. While this calculator has worked quite well for me - be warned It is not always 100% accurate (due to implied volatility when market swings or becomes calm).
The scenario that screenshot depicts is if one bought out-of-the-money AMZN $2000 January 2020 CALLs when AMZN was trading at $1608.
As you can see, it is enough for AMZN price to go up only to $1800 by January 2019 (which means that CALL contract is still out of money), but you are making profits (green area). If you keep holding longer then due to Theta options would decay and you would be at a loss (red).
