When People Buy Call Options: Beyond Exercise and Expiration
When people buy call options, the notion that you only have to either exercise the options or let them expire worthless is a common misconception. This article delves into the various strategies and insights you can use to optimize your call option positions beyond these two choices. Let's explore the reasons why having a more strategic approach can significantly enhance your trading outcomes.
Understanding the Basics: Exercise and Expiration
To clarify, exercising a call option means gaining the right to buy the underlying stock at the specified strike price. Conversely, leaving the option to expire worthless means you forfeit any value if the option price falls below the strike price. These two choices are indeed the most straightforward outcomes, but they are not the only options available to traders.
Exploring Alternative Strategies
One of the most effective strategies to manage your call option position is to utilize various tactics over a 45-day period. This timeframe provides ample time to fine-tune your trading strategy and aim for a profitable outcome. Among the techniques, the Strangle strategy is particularly valuable, especially when dealing with a range-bound underlying asset like AAPL.
The Strangle Strategy: A Delta Neutral Approach
The Strangle strategy involves simultaneously holding both a long call option and a long put option, both situated at out-of-the-money (OTM) levels. By doing so, the trader maintains a delta-neutral position, which helps in managing the underlying asset's price movements effectively. This strategy is especially useful when the underlying asset is range-bound, making it less likely to move in a direction where you would lose significant value.
Real-World Example: AAPL and the 4/9 Open
Let's look at a practical example using AAPL. On 4/9, AAPL showed upward momentum, opening at 270.55, influenced by the surge in the NASDAQ during extended hours. As the market opened, the price dropped to 265.03, nearing the short-term pivot price. Understanding the resistance and support levels, you can better time your entry and exit points.
Preset Values for AAPL
Before trading, it's crucial to preset your resistance and support levels. For this example, the resistance price is set at 270, and the support price is set at 263. This range provides a clear indication of the price volatility within the first hour of the market opening, the most volatile time period of the day, aside from the close.
Timing and Market Choices
To maximize profits, you want to buy a call option when the underlying asset is near the lower end of the price range. For the 17 APR 2020 option, with an expiry date in 8 days, you should consider an ATM (At-The-Money) strike price of 265, given the current conditions. This strike price has a delta of 0.60 and a theta decay of 0.31, which are favorable signs of sustained volatility within the next 8 days.
Understanding Delta and Theta
Delta measures the sensitivity of the option price to changes in the underlying stock price. A delta of 0.60 means that for every dollar increase in the underlying stock price, the call option price is expected to increase by $0.60. On the other hand, Theta measures the rate of decrease in the value of the option due to the passage of time. A theta decay of 0.31 indicates that the option's value is expected to decrease by $0.31 per day. These metrics are crucial in gauging the likelihood of a successful trade.
Market Conditions and Pricing
As the market is currently closed, the ask price for the 17 APR 2020 265 strike price is $7.90, and the bid price is $7.60. The bid/ask spread of $0.30 is significant in determining your final profit. While a spread of less than $0.10 is desirable, it's essential to be aware of potential shocks and volatility, which can widen the spread unexpectedly.
Profit Calculation and Management
Assuming AAPL reaches $270 per contract (100 shares), the profit from the call option exercise is calculated as follows:- Strike Price: $265- Selling Price: Bid Price $7.60- Spread: $7.60 - $7.90 -$0.30- Basis Price Change: $270 - $265 $5- Profit from Basis Move: $5 - $0.30 $4.70 per share- Total Profit: $4.70 * 100 $470
Given the spread and basis price movements, the trader can expect a profit of around $470, minus the $0.30 spread.
Opting for Vertical Spreads to Offset Drawdowns
Another strategy to manage losses is to use vertical spreads. By shorting a call option and buying a put option with the same expiration but different strike prices, you can create a vertical spread. This strategy can help offset any losses from the call option position, ensuring that you do not leave the option to expire worthless.
Conclusion
The common belief that one must either exercise a call option or let it expire is a limiting view. With a strategic approach and a keen understanding of market dynamics, traders can optimize their positions, minimize risks, and maximize profits. Whether through strangles, vertical spreads, or other trading strategies, the key is to be prepared and adapt to the changing market conditions.
Remember, while options trading is a valuable tool in a trader's arsenal, it is not without its challenges. It requires extensive study, experience, and a sound risk management strategy. As you continue to refine your skills, you will be better equipped to navigate the complexities of the options market and achieve your trading goals.