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So I made my first options transaction. I believe that a stock that is currently trading around 25, will be in the 40s, come August - based on my research (I know the stock well, and I've invested in stocks for quite some time).

So: Current NYSE stock price $25. August 1st $27 Call, 10 contracts bought, at roughly 0.80 ($800 cost basis). This option is now trading at 1.50, as the stock has started to move upwards.. has a long way to go IMO.

My question relates to what I should do if my scenario comes true . Let's say in three weeks this stock goes to $35. So I'm in July beginning, options are going to expire in a month.

  • Should I sell the call ? The Options strike price was 27, the stock is at 35. How it will work out if I do this. I've never sold a call before.

  • I am bullish on this stock - so should I exercise these options - of course I'd need money to exercise 10 contracts (which is a 1000 shares, i.e. 27K).

I know things might not go per plan - but my question is more about if/when I need to exercise it, if this scenario happens (I am OK with losing initial investment of $800).

  • Sorry. corrected strike price to 27. – blispr Jun 11 '18 at 16:12
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You've gotten some good advice answering your questions but not much in regard to managing your position.

You face two obstacles, time decay and share price reversal. Time decay is easy. Between now and August expiration, you are going to lose 80 cents per $27 contract unless share price moves up. On an expiration basis, share price must be $27.80 for you to break even. Break even will occur at a lower price than $27.80 if your stock's price has risen somewhat before expiration.

Some option info before proceeding. Delta is the amount that an option will rise or fall per dollar change in the underlying. An at-the-money option has a delta of about 0.50 and as a call rises, its delta will rise. If your stock is $35 in early July, your call's delta will be close to 1.00 which means that your call will be acting like the stock. For every dollar the stock rises, your call will rise a dollar. At this point, you will have significant risk (loss of profits).

At $35, there will be no time premium remaining in the call and you will have lost the 80 cents of time premium. However, the call will be trading for intrinsic value which is $8 ($35 - $27) so your gain will be $7.20 per call. That's the risk. What to do?

If $7.20 is acceptable, simply sell the calls to close (B/A and fewer commissions). The only reason to exercise the call is because

  1. You want to own the stock

  2. The bid price is trading below parity (less than intrinsic value) and you don't want to take the haircut for STC (I'll explain this later if you want). Obviously, you would need the cash (or margin) to support this trade.

Reaching $35 in early July is short of your target price in the 40's by August expiration. If you want to participate in further upside movement, you have to make some decisions. You could just ride the existing position, risking the $7.20 profit per contract. Or you could use some more sophisticated option strategies to pull some money off the table. I'll just mention two of the possibilities.

  1. Convert the position to a strangle. Spend another 80 cents (price guess) to buy the August 33 put. The most you could give back if the stock dropped would be $2.80 (the cost of the put plus the drop to the put's $33 strike). What does this mean? You would be guaranteed a profit of $4.40 between $27 and $33 and that $4.40 profit would increase one dollar for every dollar your stock was above $33 or below $27. So for example, at $40, your call position would have a $11.40 gain ($40 - $27c - $0.80 - $0.80), only 80 cents less than had you done nothing. If the stock collapsed to $20, you would also have a profit of $11.40 because of the put ($33p - $20 - $0.80 - $0.80). Risk and reward go hand in hand so if you want a better result on one side, you have to give up something on the other side.

  2. Roll the Aug $27 calls up to cheaper calls at a higher strike price of the same or later expiration. This pulls money out of the position, booking gains. The trade off is that you will now have a lower delta and your position will no longer track the underlying $1 for $1. Suppose you sold the $Aug 27 call for $8 - booking the $7.20 profit and duplicated your original position by buying the Sep $37 call for 80 cents. The delta of the Sep $37 call would be 35, similar to your original position. You've eliminated the risk of losing a terrific profit but in return, you have also lowered your potential profit going forward. Trade offs.

This may sound a bit daunting but if you are going to trade options, you should also learn about money management as well. You have to decide if you want to take the win, continue to risk it all, or lock in some gains while cutting risk and diminishing the total profit potential somewhat.

  • Thanks for the projected calculations - this was kind of what I was looking for. – blispr Jun 11 '18 at 19:49
  • One thing to factor in here is the early exercise calculation on dividends (IFF this is a dividend stock) While you're not hedged so you don't have to pay a short dividend you could still collect a dividend if you exercise and they pay out a dividend before expiry. The stock will also lose value with a dividend – ford prefect Jun 12 '18 at 0:04
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    Under what circumstances are you suggesting that there will be a short dividend to pay out??? Exercising to collect a dividend provides ZERO Total Return so I'm not sure under what circumstances you see that as viable. Dividends are priced into the options (puts increase and calls decrease prior to ex-div). Unrelated to the OP, a common mistake that noobs make is seeing what appears to be a fat put premium and selling a short put to capture it, not realizing that part of that premium is the dividend. There are no free lunches in this. – Bob Baerker Jun 12 '18 at 0:34
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The way option traders make a lot of money is by flipping their contracts. It takes courage, and one can easily lose all the initial "investment" at anytime. Investment is in quotes because maximizing profit in the manner I am about to describe is speculation, not investment.

Lets assume that you KNOW that a stock will rise $1 per day for the next 30 trading sessions. So it will go from $25 to $55. Also assume that no one else knows this but you. Lets also assume that you know the bump will happen between 11 and 2. And that you have $1,000 to start with.

On the first day you would buy the maximum number of contracts that you could with your 1,000. You would aim for slightly out of the money contract (less than $.50) with short expiration dates. Those options are pretty much worthless, so you could get a lot of them for your $100. Then the bump happens. Your out of the money options are now in the money and have a real tangible value. You probably made 3-10x on your money, so you will be left with at least 3k or so. You sell them.

Each morning you could repeat this pattern. One could turn that 1,000 into 6.5 million in 9 trading sessions, always rolling the maximum amount.

While those kinds of numbers are impractical they were possible when things like the Enron crash occurred. Many people are betting exactly that on Tesla, however, they keep losing large sums of money.

- OR -

You can also make a very conservative bet, that could yield a healthy return. Buy leaps. You could buy a 1 or 2 year leap, with a strike of 40, for a small amount. This way if August comes and goes, and there is no bump in price you could hold them for longer; or, sell them at a small loss.

If there is a smaller than expected bump, you could still profit.

If there is a large bump, you will likely make in the 3x or 4x range for a relatively small change in stock price.

The plus side is that, you could participate in a much larger growth, with leaps, than if you had just bought the stock. And you also have significant downside protection.

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    Useful to know about leaps. I'm not a frequent trader so flipping wouldn't work for me. This was a situation where : 1) I felt convinced (might be proven wrong yet!) 2) Normally I'd just buy shares (as is my habit) - but I had no funds left to invest - so options was a low cash way of participating in this stock's potential gain. – blispr Jun 11 '18 at 16:52
  • In your situation, I would advise for leaps. You give up some upside, but you gain a lot of downside protection. What if you are off on the timing by a quarter or so? Well then leaps are your friend. – Pete B. Jun 11 '18 at 16:56
  • I will have to research Leaps. I just got approved for trading options - so I'm not sure if I need to get approved for Leaps as well. – blispr Jun 11 '18 at 17:15
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    @blispr - You do not have to be approved to buy LEAPs. They are simply long term options (one year or longer). They are a more conservative approach to your hypothetical stock going into the $40's by August expiration and will make a fraction of what shorter term options will make. The trade off is that with so much time until expiration, you will have hardly any theta (time) decay in 2 months and they will have salvage value if the stock were to head south instead. – Bob Baerker Jun 11 '18 at 18:06
  • @blispr - You should Google "Stock Replacement Strategy" and read how high delta ITM call LEAPs can be used as a lower cost, lower risk replacement for long stock. – Bob Baerker Jun 11 '18 at 18:07
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Should I sell the call ?

Your current downside risk is if the stock begins to fall, the value of your options will fall as well. There's no risk of you losing any more cash since you already paid for the options and they can't go below zero.

You could lock in your gains by selling the call. The risk at that point is that you miss out on any gains based on the underlying stock rising. If you want to limit your loss from here, you could put in a stop-loss sell order at some point (note that your stop point will be the price of the option that you want to sell at, not the price of the underlying stock).

How it will work out if I do this. I've never sold a call before.

You would place a "sell to close" order. The simplest is to place a market order (just sell at whatever price you can sell for immediately), or a limit order (sell at price X or higher), which might get you more, but might not get filled at all if the price doesn't reach X. You sell the call to someone else (it doesn't matter who - the exchange takes care of this for you), you get the premium you sold the option for in cash, and you no longer have any position on the option. Any profit or loss from the difference in premium is locked in.

The alternative is, of course, is to ride the call to expiry and decide at that time whether you still think the stock has room to grow or whether you want to sell the stock.

of course I'd need money to exercise 10 contracts

If you don't have the cash to exercise (and/or don't want to buy the underlying stock), then the next best option is to sell the option to close your position on the day that the option matures. The difference in value between the option and the profit you'd get from exercising and selling the stock is minimal at that point, and should be slightly in your favor.

my question is more about if/when I need to exercise it

Very rarely is it worth exercising an option early. You will get more by selling the option than you will by exercising it and selling the stock for a profit.

  • This is the best answer. Exercising the option would not be advisable unless you are bullish on the stock long-term. If the stock is thinly traded and you tried to turn around and sell the 1000 shares, you might get a worse spread from your broker. As D Stanley said, sell the option come July and take the profits or roll the option and implement a stop-loss to protect some of your upside if you think it still has room to run. – HK47 Jun 11 '18 at 16:32
  • Keep in mind that even if your option is ITM, you're stilling losing on Theta – 0xFEE1DEAD Jun 11 '18 at 17:48
  • @0xFEE1DEAD That's misleading. If the stock price is constant, the option value will decrease. But if the stock price goes up, the option value will increase. On average, the option price will remain the same. (Note that while there's the third possibility of the stock price going down, resulting in a option price decrease greater than theta, the average is still zero. This is because the option price can't go below zero, but there's no limit how high it can go. This asymmetry is balanced out by theta, resulting in zero average difference.) – Acccumulation Jun 11 '18 at 18:11
  • @0xFEE1DEAD - The option loses theta as the option goes ITM. Eventually theta goes to zero as delta goes to 100 and the position becomes all intrinsic, duplicating stock performance. – Bob Baerker Jun 11 '18 at 18:24
  • @D Stanley - "Very rarely is it worth exercising an option early. You will get more by selling the option than you will by exercising it and selling the stock for a profit." That's true unless the options are deep ITM and very close to expiration. If so, the bid will often trade below parity and exercising with immediate STC can be a way to avoid the haircut. – Bob Baerker Jun 11 '18 at 18:24
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Before your options expire, if you think the stock will keep rising, you can:

  • Sell all the options and buy new ones, to continue (high risk!) in a leveraged position on these stocks.
  • Sell enough options to finance exercising the rest of the stock options. This way you continue bullish on the stocks, but with less leverage (and therefore also less risk).

Otherwise, if you don't think the stock will keep rising at the point of expiry of your options, just sell the options. I wouldn't recommend exercising the options yourself just to sell the stock immediately, there is probably too much overhead involved.

  • If I sold the call today, I'd make 0.70 profit per share - right - for a total profit of $700. Can I expect this to be higher if the stock is at 35, say. I am worried I don't understand options. – blispr Jun 11 '18 at 16:14
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    just a note that some trading platforms allow you to "roll" options positions. By ticking a box (for example) they will automatically sell and re-buy you the same number of options in the next expiry. This may also crystallise any profits. – MD-Tech Jun 11 '18 at 16:15
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    @mastov I don't know which broker systems have it but I wrote the functionality for a professional OMS some years ago! – MD-Tech Jun 11 '18 at 16:20
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    @DStanley At both an updated strike and an updated maturity. It extends the bullish leveraged bet on the stock, if you think the stock will keep rising, but your options are about to expire. – mastov Jun 11 '18 at 16:33
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    @DStanley the automatic roll picked the same maturity change, so if you bought 2 month ahead options at the start it would buy the maturity two months hence. I forget how it worked out the strike to buy but it was a function of the moneyness you bought at. – MD-Tech Jun 11 '18 at 16:41

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