Newbie Options Trading

[Jonathan Hewitt]

Time for another newbie question. Some people have said that after the earnings report volitility (IV) should go back down, therefore decreasing cost of calls (at least the portion relating to IV, obviously any change in share price will change intrinsic value so if the stock goes up then waiting for IV to go down isn't a good strategy). My question is how long will it take after the earnings report for this effect to take place? Is it something that's immediate once all the immediate reactions to the CC take place? (thursday and friday likely) or is it a longer term type thing, like next week or next month? I know the values tracked for IV are IV30 IV60 and IV90 days but I guess I don't understand which ones matter the most, like if they are weighted differently or something.

Based on what happens AH today and then after normal trading opens again I want to know the factors I should consider when buying in. Thanks!

 

[cwerdna]

My question is how long will it take after the earnings report for this effect to take place? Is it something that's immediate once all the immediate reactions to the CC take place? (thursday and friday likely) or is it a longer term type thing, like next week or next month? I know the values tracked for IV are IV30 IV60 and IV90 days but I guess I don't understand which ones matter the most, like if they are weighted differently or something.

Based on what happens AH today and then after normal trading opens again I want to know the factors I should consider when buying in. Thanks!

From the stocks where I'd bought strangles or straddles before earnings to take advantage of the rise leading into earnings (but are fighting the negative theta), the IV crush/collapse seems to happen almost immediately on or after market open after the event.

So, in this case, I'd expect long call and put prices for the front week and front month options to all drop significantly tomorrow morning. Could be down already at the open or within the 1st 15 mins or less of open. Further out should have less of a drop, but I haven't really watched those I hardly ever dabble in those.

I know this from trying to hold some strangles/straddles thru earnings. That usually ends badly unless the stock moves REALLY BIG.

If you have Thinkorswim's desktop software, you can look at historical data under Analyze > Thinkback. I think it's only based upon closing prices though. Pick some dates before an earnings events on stocks like GOOG, AAPL, CMG and walk forward thru time, watching the IV values.

 

[Jonathan Hewitt]

From the stocks where I'd bought strangles or straddles before earnings to take advantage of the rise leading into earnings (but are fighting the negative theta), the IV crush/collapse seems to happen almost immediately on or after market open after the event.

So, in this case, I'd expect long call and put prices for the front week and front month options to all drop significantly tomorrow morning. Could be down already at the open or within the 1st 15 mins or less of open.

Sweet, thanks! I am trying to build up a LEAP position, I have bought a couple before the CC in case the price shoots up, but holding onto some cash for afterwards in case it goes down. I'm excited for this conference call no matter which direction the stock price goes!

 

[CyberDutchie]

Does anyone have an idea what the calls will do tomorrow? No after hours options trading so I have no clue.

I have noticed though that percentage wise, daily gains and losses of call options are usually much higher than the actual stock, in particular those with shorter time horizon. I have some June 22 '13 $40 Calls that traded at 16.30 last trade today. I want to excercize the calls and own the stock at $40.

 

[Jonathan Hewitt]

Does anyone have an idea what the calls will do tomorrow? No after hours options trading so I have no clue.

I was wondering the same thing. I bet they will be pretty expensive. Everybody has a price, though!

 

[ShortSlaver]

Does anyone have an idea what the calls will do tomorrow? No after hours options trading so I have no clue.

I have noticed though that percentage wise, daily gains and losses of call options are usually much higher than the actual stock, in particular those with shorter time horizon. I have some June 22 '13 $40 Calls that traded at 16.30 last trade today. I want to excercize the calls and own the stock at $40.

You may be better off just selling the calls and buying the stock. A June 40 C will go for more than an exercise right now. Lets say the stock is @ $70.00 at open and you exercise right away, expect that option to be potentially worth quite a bit more as the stock will be volatile with a massive upward trend. So why exercise with all that time premium left? Sell it and buy stock in the market.

 

[Jonathan Hewitt]

I only have a few thousand $ left to invest. Calls should give me more bang for my buck than trying to buy shares but if this thing stalls on the way up due to too many profit takers then stock would be less risky...Especially because I expect calls to have a $$$$$ premium tomorrow morning.

 

[cwerdna]

Does anyone have an idea what the calls will do tomorrow? No after hours options trading so I have no clue.

I have noticed though that percentage wise, daily gains and losses of call options are usually much higher than the actual stock, in particular those with shorter time horizon. I have some June 22 '13 $40 Calls that traded at 16.30 last trade today. I want to excercize the calls and own the stock at $40.

As for the calls, well, we don't know what it'll actually open at and close at tomorrow. Sometimes, there can be a big divergence between after hours prices (little liquidity there) and trading during normal hours.

In Thinkorswim, one can use the theo (theoretical) price calculator. It'll show you the theoretical price any optoin for a given date and adjustment to the underlying stock price and implied volatility. It at least will give you a ballpark figure.

Regarding the latter, the Greeks will tell you how sensitive option prices are to the underlying stock, volatility, etc. See Using "The Greeks" To Understand Options.

- - - Updated - - -

Sweet, thanks! I am trying to build up a LEAP position, I have bought a couple before the CC in case the price shoots up, but holding onto some cash for afterwards in case it goes down. I'm excited for this conference call no matter which direction the stock price goes!

I should clarify. Assuming the stock opens up tomorrow, the price on calls will jump due to the underlying stock being up. However, extrinsic value on calls should be lower than before earnings, due to the IV collapse/crush.

It looks like the January '14 65 call today closed at around $6.05 or $6.10

Just for kicks, using the theo price calculator, I put in a stock price of +$13, IV -20% (picked this out of the air) and date of 5/9/13: it says the theo price of a January '14 65 call would be $16.81.

Just for kicks again, I changed the above to a stock price of -$13, IV -20% (picked this out of the air) and date of 5/9/13: January '14 65 call would have theo price of $0.

Just for kicks again, I changed the above to a stock price of unchanged, IV -20% (picked this out of the air) and date of 5/9/13: January '14 65 call would have theo price of $3.81.

In Thinkorswim, for any option, you can view its intrinsic and extrinsic value. The theo price calculator doesn't show you the update those fields when you make adjustments.

 

[toastypasta]

So i have jan 2015 $35 calls. Got them a couple months ago for less than $9.
Now i don't know if it's smarter to sell them or exercise.
I want to be in TSLA. I don't need or care to gain profits right now.
But technically if i sell the options i'd gain X but the stock is higher so if i exercise it'd be worth more.
What is the right play here? I don't really understand intrinsic value and time premium.
Crash course please?

 

[Jonathan Hewitt]

What is the right play here? I don't really understand intrinsic value and time premium.
Crash course please?

I'm a newbie too, so take what I say with that in mind. Basically, as TSLA share price goes up your call value will go up as well due to intrinsic value (options are derivatives of the stock). It makes NO sense to exercise at this time as there is time value as well; you would end up more shares selling the option and buying the stock on the market if you really want shares as people are willing to pay you for that "time value" assuming the share price doesn't rocket up while you are in the middle of selling your calls, haha. Also, don't forget the options gives you a lot of leverage for what you paid for them.

The other option is to just hang onto it longer and wait to see what happens. It all depends on, well, everything...

 

[kenliles]

So i have jan 2015 $35 calls. Got them a couple months ago for less than $9.
Now i don't know if it's smarter to sell them or exercise.
I want to be in TSLA. I don't need or care to gain profits right now.
But technically if i sell the options i'd gain X but the stock is higher so if i exercise it'd be worth more.
What is the right play here? I don't really understand intrinsic value and time premium.
Crash course please?

Even with those now deep in the money, you'll have time value remaining so you'll make more selling than excersising. At close today (around $56), those options would excersise just under $2100 per contract ($56-$35). But you could sell them around $2300 per closing bid price on that option(both figures will be higher at open assuming price moves up, but e math difference will show similar). That difference reflects the time value still remaining. Given IV changes is explanation is not exact, but provides a guideline.

If you want to take some profit, but still stay in a long position, consider rolling them to a higher strike. You can do this in one trade or separate, but the play would be sell the $35 strike LEAP and replace it with a $50 strike. You'll pocket the credit difference as cash, but carry the same number of contracts for your long position. This is one of the advantages of LEAP options allowing adjustments to the forward movements of the underlying stock. Remember you do lose some in the trade as bid/ask spreads apply (like a commission on stock sale), so you don't want to do this with LEAPS on a high frequency basis, but you'll also make more profit when price warrants, especially if the stock moves rapidly enough to absorb the time value of the option into your profit (move it from ATM-at the money to DITM- deep in he money for example)

 

[cwerdna]

So i have jan 2015 $35 calls. Got them a couple months ago for less than $9.
Now i don't know if it's smarter to sell them or exercise.
I want to be in TSLA. I don't need or care to gain profits right now.
But technically if i sell the options i'd gain X but the stock is higher so if i exercise it'd be worth more.
What is the right play here? I don't really understand intrinsic value and time premium.
Crash course please?

According to my theo price calculator, assuming a stock price of +$13, IV -20%, on 5/9/13, they should be worth ~$46.85.

Yes, if you exercise, you will give up whatever extrinsic (time) value they had.

You can read up on intrinsic and extrinsic value at Extrinsic Value Definition | Investopedia and Intrinsic Value Definition | Investopedia.

You can see the intrinsic and extrinsic value based on today's close via the screenshot I attached (calls on the left). I'm looking at the really DITM calls and am confused by the negative extrinsic value on them. For Jan '15, the calls at 55 on up make sense.

BTW, back to the theo price calculator, if you were to leave a stock's price and IV alone and just keep advancing time, you'd see the values of (long) puts and calls erode over time due to the time decay. OTM calls and puts would erode to 0 (make sense, since they'd expire worthless).

edit: It seems like TOS' intrinsic and extrinsic values are out of whack because of the goofy bid and ask prices on the underlying (as opposed to the last (closing) price). The values should make sense once the market opens.

Ok, the 2nd screenshot is from Thinkback from 5/6/13 and using a strike that doesn't have such a wide bid/ask spread that should illustrate extrinsic/intrinsic value better.

On that day, TSLA closed at $59.50. I put a box around the $57.50 strike (monthly) Jun '13 call. $59.50 - $57.50 = $2. That $2 == intrinsic value. The midpoint between bid/ask for the strike is $5.95 (also is in the Mark column).

$5.95 >> $2. So, the difference between $5.95 and $2 = $3.95, which is the extrinsic value. That's the part the decays over time and also rises/falls due to rising/falling IV.

The out of the money calls (ones w/strikes higher than the underlying, which are in white) have 0 intrinsic value. They have only extrinsic value.

 

[Jonathan Hewitt]

I think I decided I'm going to try and buy 2 or 3 Jan '14 Calls at the money or slightly OTM. If the squeeze doesn't happen or stalls out I believe TSLA will be above where it is now come January, barring some huge economy meltdown or natural disaster type scenario. I will not try to catch a falling sword if it gets away too quick, though. I'm happy enough with my position how it is right now and don't want to try to force it to grow by doing something dumb.

 

[toastypasta]

According to my theo price calculator, assuming a stock price of +$13, IV -20%, on 5/9/13, they should be worth ~$46.85.

Yes, if you exercise, you will give up whatever extrinsic (time) value they had.

You can read up on intrinsic and extrinsic value at Extrinsic Value Definition | Investopedia and Intrinsic Value Definition | Investopedia.

You can see the intrinsic and extrinsic value based on today's close via the screenshot I attached (calls on the left). I'm looking at the really DITM calls and am confused by the negative extrinsic value on them. For Jan '15, the calls at 55 on up make sense.

BTW, back to the theo price calculator, if you were to leave a stock's price and IV alone and just keep advancing time, you'd see the values of (long) puts and calls erode over time due to the time decay. OTM calls and puts would erode to 0 (make sense, since they'd expire worthless).

edit: It seems like TOS' intrinsic and extrinsic values are out of whack because of the goofy bid and ask prices on the underlying (as opposed to the last (closing) price). The values should make sense once the market opens.

Ok, the 2nd screenshot is from Thinkback from 5/6/13 and using a strike that doesn't have such a wide bid/ask spread that should illustrate extrinsic/intrinsic value better.

On that day, TSLA closed at $59.50. I put a box around the $57.50 strike (monthly) Jun '13 call. $59.50 - $57.50 = $2. That $2 == intrinsic value. The midpoint between bid/ask for the strike is $5.95 (also is in the Mark column).

$5.95 >> $2. So, the difference between $5.95 and $2 = $3.95, which is the extrinsic value. That's the part the decays over time and also rises/falls due to rising/falling IV.

The out of the money calls (ones w/strikes higher than the underlying, which are in white) have 0 intrinsic value. They have only extrinsic value.

Would you suggest rolling Jan15 $35 calls to something like JAN 15 $60 calls or even higher?
Could take some profit and stay long.

 

[kenliles]

Would you suggest rolling Jan15 $35 calls to something like JAN 15 $60 calls or even higher?
Could take some profit and stay long.

The $35s have wrung out the time value profit; I rolled all my J15 $40-$45 up to $60 this morning

 

[toastypasta]

The $35s have wrung out the time value profit; I rolled all my J15 $40-$45 up to $60 this morning

I rolled them to JAN14 $80's. Netted 300% profit after the roll.
amazingness.
Played some JUN $90's this morning. up 100% today. going to take those profits too.

 

[cwerdna]

BTW, here's a screenshot from near the close of trading on 5/9/13 showing extrinsic and intrinsic values not all screwed up, since the market was open. Hopefully my earlier examples, links to definition along w/this make things more clear.

 

[CyberDutchie]

I want to understand the tax implications of exercising an ITM call versus selling the call and buying the underlying stock at market.

Lets say I bought one June 22 '13 $40 Call contract for $7.50 and on expiration day TSLA is at $70, with zero time value left on the call.

Scenario 1: I sell to close the call for $30, make $2250 profit and pay the max 39.5% short term capital gain tax of $889. Then buy 100 shares on the open market at $70 for an effective cost of $7000 - $2250 + 889 = $5639. Cost basis for future gains is $7000.

Scenario 2: I let the call expire and I get 100 shares at $40 for an effective cost of $4000 + $750 = $4750. I don't pay any tax when exercising, but cost basis for future gains is $4750.

Lets say after a year, they are at $100 and I decide to sell.

Scenario 1: I make $10000 - $5639 = $4361 profit but pay 15% long-term capital gain tax over only $3000 = $450. So my real gain is $4361 - $450 = $3911

Scenario 2: I make $10000 - $4750 = $5250 profit and pay 15% long-term capital gain tax over $5250 = $788. So my real gain is $5250 - $788 = $4462

Comparing these two scenarios, exercising at expiration date seems the way to go since you avoid short-term capital gain. Did I see this right?

 

[kenliles]

I want to understand the tax implications of exercising an ITM call versus selling the call and buying the underlying stock at market.

Lets say I bought one June 22 '13 $40 Call contract for $7.50 and on expiration day TSLA is at $70, with zero time value left on the call.

Scenario 1: I sell to close the call for $30, make $2250 profit and pay the max 39.5% short term capital gain tax of $889. Then buy 100 shares on the open market at $70 for an effective cost of $7000 - $2250 + 889 = $5639. Cost basis for future gains is $7000.

Scenario 2: I let the call expire and I get 100 shares at $40 for an effective cost of $4000 + $750 = $4750. I don't pay any tax when exercising, but cost basis for future gains is $4750.

Lets say after a year, they are at $100 and I decide to sell.

Scenario 1: I make $10000 - $5639 = $4361 profit but pay 15% long-term capital gain tax over only $3000 = $450. So my real gain is $4361 - $450 = $3911

Scenario 2: I make $10000 - $4750 = $5250 profit and pay 15% long-term capital gain tax over $5250 = $788. So my real gain is $5250 - $788 = $4462

Comparing these two scenarios, exercising at expiration date seems the way to go since you avoid short-term capital gain. Did I see this right?

In scenario 2, you're buying the shares with $s that have already been taxed at $39.5% (compared to $750 in scenario 1);
In addition the scenarios aren't equal in time until expiration, for example you could sell those today for $37 overcoming the difference plus some;

 

[Johan]

Just a little shout-out to everyone who chimed in so far on this thread. The things I learned in the last weeks enabled me to make a good (although quite risky) option move this morning: Bought a bunch of May '13 $75 calls for $2.03 (TSLA was slightly down just at market open) - these are as of now of course in the money and (TSLA at $78.73) trading at $6.50 so that's more than 300% in less than 6 hours... Insane. Now, with expiry so close (they expire in 7 days) I would like some advice on how to play it from here on. My view is TSLA will be up more at the end of the day on Monday, perhaps substantially up for different reasons (margin calls often give shorts 2 trading days to cover or secure with cash, Elon just might drop a news bomb etc, TSLA might be added to various funds etc.), but for every day closer to expiry the time value will drop a lot guess. Current price of $6.50 is roughly $2.7 time-value (extrinsic) and $3.7 intrinsic value. When I bought them they were out-of-the money so the price I paid ($2) was 100% extrinsic value. And now we are closer to expiry and even so extrinsic value is up??? Can someone explain this to me?