Newbie Options Trading

[Johan]

I have just started reading this massive thread #goodlucktome, but have a question in the meantime.

I own _00 shares bought in tranches since 8/14 (slightly under water overall) and have been selling covered calls for the past 18 months, at least until prices went down so low with the recent share swoon. Nothing especially clever, but I have netted 10% of my long investment. Thought I had an airtight strategy, but it has suddenly dawned on me that I may have misunderstood the risks I was taking.

My question is "What percentage of in the money covered calls are exercised once the delta from current market price reaches $x or x%, vs. being held until the expiration date?"

After witnessing one of my covered calls go in the money several weeks before expiration, and then decline and never be exercised, I'm wondering if the risk of selling covered calls is higher than I realized. I had been thinking that the call would almost definitely be exercised once the market price exceeded the exercise price by ~$x or x%, but if usually held until expiration during a market updraft, there's a possibility the delta could be $10 or $15 (an amount exceeding the covered call premium), and I couldn't recover that delta by repurchasing at a lower price after exercise and market fluctuation.

Can someone please help me? :crying:

Could you reframe your question please? Of course you can lose money selling calls, and you can have your shares called away, but time decay works for you and not against you (as it would do if you had bought puts instead). Most options, both puts and calls are never exercised but instead are cancelled out by an inverse transaction (for example in your case buying back a call with identical expiry and strike, possibly at a loss). If your shares do get called away you can just repurchase at market price (the delta minus premium collected being your loss) to replace the shares that got called away.

 

[CHGolferJim]

Could you reframe your question please? Of course you can lose money selling calls, and you can have your shares called away, but time decay works for you and not against you (as it would do if you had bought puts instead). Most options, both puts and calls are never exercised but instead are cancelled out by an inverse transaction (for example in your case buying back a call with identical expiry and strike, possibly at a loss). If your shares do get called away you can just repurchase at market price (the delta minus premium collected being your loss) to replace the shares that got called away.

Thanks, I understand your last sentence, but not how to rephrase the question.

I had based the strategy on the assumption that my shares would be called away as soon as the market price (say $240) exceeded the exercise price (say $235) by enough that the buyer could attain shares at a discount after transaction costs. Let's say I received $12 as a call premium. Then, given usual volatility, as long as I could repurchase at <$247 I would have a profit. Now I'm perceiving that I might not have my shares called until the expiration date, with the possibility the market price could be higher and I couldn't repurchase at <$247.

Thus my question, when do call options typically get exercised, as soon as they go sufficiently in the money, or at expiration (if in the money)?

 

[The Blue Owl]

Thanks, I understand your last sentence, but not how to rephrase the question.

I had based the strategy on the assumption that my shares would be called away as soon as the market price (say $240) exceeded the exercise price (say $235) by enough that the buyer could attain shares at a discount after transaction costs. Let's say I received $12 as a call premium. Then, given usual volatility, as long as I could repurchase at <$247 I would have a profit. Now I'm perceiving that I might not have my shares called until the expiration date, with the possibility the market price could be higher and I couldn't repurchase at <$247.

Thus my question, when do call options typically get exercised, as soon as they go sufficiently in the money, or at expiration (if in the money)?

Jim, I answered your question. Most of the time they get exercised at expiration if in the money, or they expire worthless. Rarely, some option holder may choose to exercise early, and you may get assigned, but it's exceedingly rare. If it happens, you can take your money and re-buy the shares on the market. More experienced traders can tell us how often that happens. It never happened to me, and I bet it is very rare, because it's not profitable for the option holder to exercise early. Deeper-into-the-money options are more likely to be exercised early.

This link explains it in more detail.

Also, you can repurchase options to close your trade anytime you want. You don't have to wait on the other side to exercise in order to close your trade.

 

[Johan]

Thanks, I understand your last sentence, but not how to rephrase the question.

I had based the strategy on the assumption that my shares would be called away as soon as the market price (say $240) exceeded the exercise price (say $235) by enough that the buyer could attain shares at a discount after transaction costs. Let's say I received $12 as a call premium. Then, given usual volatility, as long as I could repurchase at <$247 I would have a profit. Now I'm perceiving that I might not have my shares called until the expiration date, with the possibility the market price could be higher and I couldn't repurchase at <$247.

Thus my question, when do call options typically get exercised, as soon as they go sufficiently in the money, or at expiration (if in the money)?

It helps to think of it this way: when you sell a call you're making a bearish move. When someone buys a call this is a bet that the stock will go up. There's always an open interest for any given strike and expiration. Someone buying a call doesn't necessarily buy your call, but a call from a pool of those calls. If the stock goes up the call that you sold may become in the money. However this means that whoever bought such a call has had his call go up in value. Mostly people will then sell the call for a profit rather than exercise it. As you near expiration you're probably going to end up having the marketmaker owning the call that you bought. What the marketmaker is really hoping for is that you will see that your call may be exercised and therefore you will close the trade, at a loss, before expiry. If you don't the marketmaker is going to exercise the call, and likely sell the shares immediately on the open market to take the profit. But in reality it's better for the marketmaker if you close the trade before expiry, since they're making money on the spread between ask and bid price.

 

[CHGolferJim]

First answer: "Most options, both puts and calls are never exercised but instead are cancelled out by an inverse transaction (for example in your case buying back a call with identical expiry and strike, possibly at a loss)."

Second answer: "Most of the time they get exercised at expiration if in the money, or they expire worthless."

Both are true?

 

[The Blue Owl]

First answer: "Most options, both puts and calls are never exercised but instead are cancelled out by an inverse transaction (for example in your case buying back a call with identical expiry and strike, possibly at a loss)."

Second answer: "Most of the time they get exercised at expiration if in the money, or they expire worthless."

Both are true?

Yes for the second, no for the first. Most options are never exercised, because they are held to expiration. In the meantime, they get traded on the market like every other security. There is no persistent connection between the buyer and the seller of an option contract. You can buy a call from a seller, then sell it to somebody else. They trade exactly like stocks.

Option contracts are fungible. You can sell your contracts to any willing buyer. There is no requirement to cancel anything out.

In your case, as an option seller, you can decide to buy your calls back on the open market at any moment.

- - - Updated - - -

To clarify: I didn't mean to say the first quoted statement was wrong, just that that's not the reason why options are rarely exercised early. The real reason is that it's not profitable to do so.

Option sellers buy their contracts back all the time. It's just that the action of buying them back isn't anything special; it's just a transaction like any other. Some option writers may decide to close their short option position by buying their options back, while others write new contracts. All open contracts on the market are constantly being traded in all directions, while their fuses are burning towards expiry. Whoever holds the ones in the money on expiry date enjoys the fireworks.

 

[Johan]

A simple explanation for why it makes no sense to exercise an option that's in the money early (exercising options that are out of the money is unheard of, now that would really be stupid) is that it will have value comprised of two parts: 1. Intrinsic value (how much it's in the money) and 2. Time value. By exercising early you give away the time value. Why would you (anyone) want to do that?

 

[dmunjal]

A simple explanation for why it makes no sense to exercise an option that's in the money early (exercising options that are out of the money is unheard of, now that would really be stupid) is that it will have value comprised of two parts: 1. Intrinsic value (how much it's in the money) and 2. Time value. By exercising early you give away the time value. Why would you (anyone) want to do that?

I do it all the time because I trade options and hardly ever hold them to expiration. If I can make a quick 50%, I'm out and get back in when it reverses. Up or down.

 

[The Blue Owl]

I do it all the time because I trade options and hardly ever hold them to expiration. If I can make a quick 50%, I'm out and get back in when it reverses. Up or down.

You're not exercising your options, you're just trading them. The discussion was about exercising them (i.e., converting them to shares at the strike price).

 

[dmunjal]

You're not exercising your options early, you just trade them. The discussion was about exercising them (i.e., converting them to shares at the strike price).

Sorry. Misunderstood.

Agree that there is no reason to exercise them early.

 

[CHGolferJim]

Thanks guys, I'm understanding better.

As an example, why wouldn't an owner of an in-the-money call option with an exercise price of $200 do an exercise-and-sell-the-shares transaction if the market price was $210 and their transactions costs were $5/share (and ignore timing vs. expiration)? They'd make $5 a share. Are transactions going to be more than $500 per contract (of 100 shares)?

 

[The Blue Owl]

Thanks guys, I'm understanding better.

As an example, why wouldn't an owner of an in-the-money call option with an exercise price of $200 do an exercise-and-sell-the-shares transaction if the market price was $210 and their transactions costs were $5/share (and ignore timing vs. expiration)? They'd make $5 a share. Are transactions going to be more than $500 per contract (of 100 shares)?

Let's ignore the transaction costs per share ($5/share is an awfully high number; I doubt it exists). Then, in your example, they'd make $10 a share. But they'd be leaving money on the table, because the call contract before expiration will be worth more than that. That's because in addition to the $10 dollars of intrinsic value (intrinsic value = actual stock price - call strike price), the call price also incorporates the time premium.

For instance, right now TSLA shares are at $188.34. However, the 180 call expiring on Apr 8 is worth $16.08. If you converted your call to shares and sold them, you'd be getting a profit of $8 per share, whereas if you simply sold the call, you'd get $16. The extra $8 is the time premium.

 

[dandurston]

Options

I could use a little help ensuring I have this options thing understood. Here's a screenshot of what I'm looking at in my trading account:

View attachment 113531

So if I execute this transaction, it would give me the right to buy 100 shares of SCTY for $25 each on Jan 18, 2018. This cost for the deal is somewhere between $4.60 - $6.20 per share, so the total cost would be $460 - $620. Right?

A few questions:
1) Can I execute the option at any time between now and Jan 18, 2018? Or just on that date?
2) What if SCTY does well and I don't have the money to actually buy the shares? I assume I can just sell the option for it's new value. Perhaps it's best to buy the stock and then sell that, because the bid/ask spread is normally much tighter as a % of the value.
3) The bid and ask sizes are referring to bundles of 100 right? So the last bid was actually to pay $4.60/share for 23200 shares?

To my novice eye, the bid/ask spread seems huge and could easily be ones undoing. If I ended up buying at $6.20/share and then later decided to sell while SCTY was flat and sold for $4.60/share I'd end up losing ~30% without any change in the underlying stock. Is there a good strategy for not losing like this? Is it a good idea to set a limit at the midpoint of the bid/ask spread? E.g. $5.40/share.

Thanks for the help! I tried to read this thread but it's long.

 

[MikeC]

I could use a little help ensuring I have this options thing understood. Here's a screenshot of what I'm looking at in my trading account:

View attachment 113531

So if I execute this transaction, it would give me the right to buy 100 shares of SCTY for $25 each on Jan 18, 2018. This cost for the deal is somewhere between $4.60 - $6.20 per share, so the total cost would be $460 - $620. Right?

A few questions:
1) Can I execute the option at any time between now and Jan 18, 2018? Or just on that date?
2) What if SCTY does well and I don't have the money to actually buy the shares? I assume I can just sell the option for it's new value. Perhaps it's best to buy the stock and then sell that, because the bid/ask spread is normally much tighter as a % of the value.
3) The bid and ask sizes are referring to bundles of 100 right? So the last bid was actually to pay $4.60/share for 23200 shares?

To my novice eye, the bid/ask spread seems huge and could easily be ones undoing. If I ended up buying at $6.20/share and then later decided to sell while SCTY was flat and sold for $4.60/share I'd end up losing ~30% without any change in the underlying stock. Is there a good strategy for not losing like this? Is it a good idea to set a limit at the midpoint of the bid/ask spread? E.g. $5.40/share.

Thanks for the help! I tried to read this thread but it's long.

1) Just sell the option anytime. As per the discussion immediately above, there's no point in exercising before it expires because you would lose the time value.

2) Of course you can sell the option for the new value, that's the goal.

3) The bid and ask are for the contract, which is the right to buy the shares - actually buying the shares at the strike price is kind of a separate transaction.

4) Yes, wide bid-ask spreads suck. Always use a limit order for options - to buy in your example, maybe start at 5.00 and go up in small increments of $0.10. The transaction will go through before you get to the actual asking price. But it's also a moving target because the share price itself is constantly moving.

 

[CHGolferJim]

Let's ignore the transaction costs per share ($5/share is an awfully high number; I doubt it exists). Then, in your example, they'd make $10 a share. But they'd be leaving money on the table, because the call contract before expiration will be worth more than that. That's because in addition to the $10 dollars of intrinsic value (intrinsic value = actual stock price - call strike price), the call price also incorporates the time premium.

For instance, right now TSLA shares are at $188.34. However, the 180 call expiring on Apr 8 is worth $16.08. If you converted your call to shares and sold them, you'd be getting a profit of $8 per share, whereas if you simply sold the call, you'd get $16. The extra $8 is the time premium.

Excellent, thank you. I was thinking of going to the tables for some examples suspecting what you outlined.

 

[dandurston]

Thanks a lot MikeC! Makes total sense.

 

[Johan]

4) Yes, wide bid-ask spreads suck. Always use a limit order for options - to buy in your example, maybe start at 5.00 and go up in small increments of $0.10. The transaction will go through before you get to the actual asking price. But it's also a moving target because the share price itself is constantly moving.

Just to add to this, something someone may find useful, the broker I'm using - Charles Schwab, OptionsXpress - has an order call "Walk limit" where you enter a starting point and and end point, and the increment, so for example if you're buying you put the lowest bid price as start point, the ask price as end point and then the order updates every 10 seconds with small increments in your bid, until the trade goes through. In other words what Mike is describing here only automated. I always use this feature.

 

[dandurston]

That's a nice feature. With SCTY sky rocketing today and my trading account having 15 minute delayed quotes/prices this hasn't been easy. Too bad I didn't get the order in yesterday when SCTY was 20% lower. At least I bought some stock last week at $18.

 

[JBRR]

Can anyone help me find ISIN code for Tesla Jan17 calls?

 

[VanE]

Hi everyone. I've been trading TSLA stock for a little over a year now (both short and long term). And start reading about options in the last couple of weeks. I have a brokerage account at my (Dutch) bank where I also have my bank account. I can trade most stock there and some other products like turbo's and some options, but no options for TSLA. How do you guys trade options, and are such accounts available for international clients? Or are any of you Dutch/European?

I'm looking forward to your tips!