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December 6, 2007 8:30 AM Subscribe
question on stock options: is volume an issue? If I sell to close in the final 3 weeks, who is it that is buying it? why would they buy it?
I'm dabbling in basic stock options.
As a noob, I'm only dealing with bulling long positions by buying call options about 9 weeks before expiry and then selling them in the final month before expiry. As a further precaution I'm only dealing with mainstream 'blue chip' stocks (ones that i happen to be bullish on for a 9 week timeframe).
First question: do you see any catastrophic risks with this dabbling (other than my losing my initial investment, which is obviously a risk i'm willing to take)? I just want to make sure I wont have 'unlimited' risk, or that I wont be asked to deliver the underlying stocks to someone. As I understand it, when you buy calls, neither of those should happen.
Second question: In general, what is a good time to sell a call? There is time decay in the final 4 weeks, right? So as a general rule does it make sense to close out a call with about 4 weeks left before expiration? (taking whatever profit you have on it and if you dont expect anything much more)
In general I'm comfortable with buying the calls about 3-months (9 to 12 weeks) before expiration. Any issues with that that you can see, that I should be aware of? How far ahead do you buy your calls?
Third question: Is volume an issue - when it comes time that I want to sell my call to close it, in the last 3 or 4 weeks, who is buying this thing? Institutions? What is the difference between volume and 'open interest' (if i want to gauge if there will be buyers)?
I'm dabbling in basic stock options.
As a noob, I'm only dealing with bulling long positions by buying call options about 9 weeks before expiry and then selling them in the final month before expiry. As a further precaution I'm only dealing with mainstream 'blue chip' stocks (ones that i happen to be bullish on for a 9 week timeframe).
First question: do you see any catastrophic risks with this dabbling (other than my losing my initial investment, which is obviously a risk i'm willing to take)? I just want to make sure I wont have 'unlimited' risk, or that I wont be asked to deliver the underlying stocks to someone. As I understand it, when you buy calls, neither of those should happen.
Second question: In general, what is a good time to sell a call? There is time decay in the final 4 weeks, right? So as a general rule does it make sense to close out a call with about 4 weeks left before expiration? (taking whatever profit you have on it and if you dont expect anything much more)
In general I'm comfortable with buying the calls about 3-months (9 to 12 weeks) before expiration. Any issues with that that you can see, that I should be aware of? How far ahead do you buy your calls?
Third question: Is volume an issue - when it comes time that I want to sell my call to close it, in the last 3 or 4 weeks, who is buying this thing? Institutions? What is the difference between volume and 'open interest' (if i want to gauge if there will be buyers)?
There are no catastrophic risks as long as you are buying (not writing) them. You can only lose as much as you put down at the start.
Double-check with your broker to make sure they are cash-settled (don't require delivery), but yes, that's usually the case.
No hard and fast rule about when to sell. There is always time decay, it's just that it accelerates as you get closer to expiry.
There are tons of issues you need to be aware of. Options trading is extremely difficult to do right. Because of the time decay AND changes in volatility, it's a lot harder to do then buying into the underlying. Mistakes in timing are much less forgiving with options.
You need to learn the Greeks; if you don't understand them, you probably won't make money in the long run.
Go to ThinkOrSwim.com and download their software (free with registration). You can "paper trade" (not real money) to see how you do with hypothetical trades.
Generally, I'd say that if you're looking for more leverage with your investments, look at ETFs before you go to options. Options are just too tricky for most investors, and the tuition can be quite expensive.
posted by mikeand1 at 8:52 AM on December 6, 2007
Double-check with your broker to make sure they are cash-settled (don't require delivery), but yes, that's usually the case.
No hard and fast rule about when to sell. There is always time decay, it's just that it accelerates as you get closer to expiry.
There are tons of issues you need to be aware of. Options trading is extremely difficult to do right. Because of the time decay AND changes in volatility, it's a lot harder to do then buying into the underlying. Mistakes in timing are much less forgiving with options.
You need to learn the Greeks; if you don't understand them, you probably won't make money in the long run.
Go to ThinkOrSwim.com and download their software (free with registration). You can "paper trade" (not real money) to see how you do with hypothetical trades.
Generally, I'd say that if you're looking for more leverage with your investments, look at ETFs before you go to options. Options are just too tricky for most investors, and the tuition can be quite expensive.
posted by mikeand1 at 8:52 AM on December 6, 2007
This is the best book on the subject.
It is a very, very good book (content wise) even if you occasionally snore.
posted by Pants! at 8:57 AM on December 6, 2007
It is a very, very good book (content wise) even if you occasionally snore.
posted by Pants! at 8:57 AM on December 6, 2007
When you buy a call option, your risk is limited to the premium you pay. You will not have to deliver the undelying asset. This is the risk that the person who writes the call option has to face. You are the buyer of the option. You can either decide to exercise the option or you can let the option lapse and lose your premium. When you buy a call option, the premium is the max you can lose.
The closer you draw to expiry, the less time value there will be in the option. An option premium is made up of intrinsic value and time value. If you have a January 70 call with a premium of 29 and the underlying value is 98, the intrinsic value of the right to buy a share priced at 98 for only 70 is 28. The extra 1 is time value. As you go out to February, March and April, the time value, and thus the premuim, will increase. Whether you exercise the option or not depends upon the underlying share price.
Options are extremely complex. I struggle to wrap my head around some of the concepts myself. I would really make sure that you know exactly what you're doing or that you have a good advisor who can explain things to you before you start dealing in any options (inlcuding plain vanilla ones).
posted by triggerfinger at 9:00 AM on December 6, 2007
The closer you draw to expiry, the less time value there will be in the option. An option premium is made up of intrinsic value and time value. If you have a January 70 call with a premium of 29 and the underlying value is 98, the intrinsic value of the right to buy a share priced at 98 for only 70 is 28. The extra 1 is time value. As you go out to February, March and April, the time value, and thus the premuim, will increase. Whether you exercise the option or not depends upon the underlying share price.
Options are extremely complex. I struggle to wrap my head around some of the concepts myself. I would really make sure that you know exactly what you're doing or that you have a good advisor who can explain things to you before you start dealing in any options (inlcuding plain vanilla ones).
posted by triggerfinger at 9:00 AM on December 6, 2007
I have learned a ton recently about stock options.
For the question of who is buying in the last few weeks, it is a group of people called Market Makers. They get some advantages (better information) in exchange for taking the opposite side of trades that don't have a match somewhere else. When they buy your call option, at the same time they short the stock. That creates a delta neutral position (no change in value on a stock price move). They make a very small amount of money with zero risk based on this position they are taking. (at least that is my understanding).
As far as closing out positions, do it earlier rather than later. Theta (time decay) starts eating your lunch as it accelerates going into the last few weeks.
For the unlimited risk issue, the only single option strategy that has unlimited risk is selling a call. Selling a put has a large liability, but it is finite. Buying either a call or a put has limited risk (what you paid for it).
As far as the suggestion for ETFs, they don't give you leverage in general (although there are a few weird ETFs out there). They are just mutual funds that happen to trade like stocks.
Open interest is how many options are out in the wild. If you buy to open, it goes up, if you sell to close it goes down (for everybody of course).
Volume is just how many were traded that day. Basically the difference is how many were in existence versus how many moved.
Go check out thinkorswim, and peruse their trainings. You can learn a TON about options via their free classes (they are archived online).
posted by cschneid at 9:06 AM on December 6, 2007 [1 favorite]
For the question of who is buying in the last few weeks, it is a group of people called Market Makers. They get some advantages (better information) in exchange for taking the opposite side of trades that don't have a match somewhere else. When they buy your call option, at the same time they short the stock. That creates a delta neutral position (no change in value on a stock price move). They make a very small amount of money with zero risk based on this position they are taking. (at least that is my understanding).
As far as closing out positions, do it earlier rather than later. Theta (time decay) starts eating your lunch as it accelerates going into the last few weeks.
For the unlimited risk issue, the only single option strategy that has unlimited risk is selling a call. Selling a put has a large liability, but it is finite. Buying either a call or a put has limited risk (what you paid for it).
As far as the suggestion for ETFs, they don't give you leverage in general (although there are a few weird ETFs out there). They are just mutual funds that happen to trade like stocks.
Open interest is how many options are out in the wild. If you buy to open, it goes up, if you sell to close it goes down (for everybody of course).
Volume is just how many were traded that day. Basically the difference is how many were in existence versus how many moved.
Go check out thinkorswim, and peruse their trainings. You can learn a TON about options via their free classes (they are archived online).
posted by cschneid at 9:06 AM on December 6, 2007 [1 favorite]
At this point, a) you don't know what you are doing b) in a complicated instrument so you should expect to do badly.
As mikeand1 asked, what are you trying to do here? If you think you know a way to pick up free money trading options, let me assure you, you do not. If you are looking for something else like leverage, lets get at that directly.
posted by shothotbot at 9:07 AM on December 6, 2007
As mikeand1 asked, what are you trying to do here? If you think you know a way to pick up free money trading options, let me assure you, you do not. If you are looking for something else like leverage, lets get at that directly.
posted by shothotbot at 9:07 AM on December 6, 2007
Response by poster: I definitely dont want to exercise the call options that i'm buying, but I do want to "sell to close" when I want to take any profit. How does that work -- when I do I'm not exercising it, I'm just closing it out, right? Am I selling it? (I'm not writing it, right?) If i'm selling it, who would buy it, especially if there's only a couple of weeks before expiration? Why would they buy it?
Thanks!
posted by jak68 at 9:07 AM on December 6, 2007
Thanks!
posted by jak68 at 9:07 AM on December 6, 2007
Response by poster: (for the record, I have a fairly decent four-year track record with trading stocks, hence my interest to branch out - cautiously - into options, mainly only on bullish calls on the underlying equity, nothing too fancy. I understand that options pricing behaves considerably differently from stock pricing, and I'm only just coming to understand the various factors involved). I've only just begun to do some paper trades.
posted by jak68 at 9:09 AM on December 6, 2007
posted by jak68 at 9:09 AM on December 6, 2007
jak68: go download the ThinkOrSwim platform, and paper trade until you understand everything going on. You should understand all the greeks, how exercise works, and everything else before risking real money. You can learn this easily if you spend the time with the TOS platform.
For the last question (regarding sell to close), you simply have somebody else pay you and they take over the right to exercise that call. You give up the call option, and they gain it.
posted by cschneid at 9:12 AM on December 6, 2007
For the last question (regarding sell to close), you simply have somebody else pay you and they take over the right to exercise that call. You give up the call option, and they gain it.
posted by cschneid at 9:12 AM on December 6, 2007
Response by poster: cschneid and others - thanks for the detailed info. I will definitely check out TOS, and yes, I will definitely paper trade for quite a while before I commit real money (having traded stocks for 6 years (out of which only the last 4 were profitable; the first two were "tuition" ;) I'm fairly cautious about commiting real money. Took me quite a while to get a profitable percentage just with stocks, so I fully expect options to be harder.
So market makers will buy my option when i sell to close; Thats good to know. (I didnt want my sell to close order to be sitting out there forever).
posted by jak68 at 9:18 AM on December 6, 2007
So market makers will buy my option when i sell to close; Thats good to know. (I didnt want my sell to close order to be sitting out there forever).
posted by jak68 at 9:18 AM on December 6, 2007
There is also unlimited risk in various strangles and straddles, it's not just call options. These are obviously more complex strategies, but learning more about options trading before you just jump into it is sound advice. Things like the Greeks would be the kind of basic knowledge you need.
posted by triggerfinger at 9:21 AM on December 6, 2007
posted by triggerfinger at 9:21 AM on December 6, 2007
triggerfinger, the reason those are unlimited risk is because they are a multi-option strategy that has an unhedged short call (hence the unlimited risk).
posted by cschneid at 9:29 AM on December 6, 2007
posted by cschneid at 9:29 AM on December 6, 2007
I started playing with options last year. My initial "tuition" for playing with options was higher than I expected and probably I would have been better off just sticking with purchasing the underlying stock. But I'm addicted to the gambling aspect.
My experience has been with buying OTM calls when the underlying stock is in a low period and I expect it to rebound within a certain amount of time. I have bought and sold both near term and long term options (LEAPS).
I'm betting on good news within a time frame equivalent to before the option expires. With OTM calls, the opportunity to make lots of money is greater, but so is the possibility that the option will expire worthless.
I mostly dabble in biotech options, but I took a chance on TASR in April when it was trading around 9. I bought January 2008 $10 calls for $1 each. In the coming months the stock shot up to double the stock price at $18, but the option went as high as $8.
Another option I played with was a near term call in ELN, where I bought it within 1 month of expiration, and sold it the day of the close as the stock was shooting up. This was a June $20 option that I bought for as little as $.15 and sold for as high as $1.90, just a week later.
posted by indigo4963 at 9:35 AM on December 6, 2007
My experience has been with buying OTM calls when the underlying stock is in a low period and I expect it to rebound within a certain amount of time. I have bought and sold both near term and long term options (LEAPS).
I'm betting on good news within a time frame equivalent to before the option expires. With OTM calls, the opportunity to make lots of money is greater, but so is the possibility that the option will expire worthless.
I mostly dabble in biotech options, but I took a chance on TASR in April when it was trading around 9. I bought January 2008 $10 calls for $1 each. In the coming months the stock shot up to double the stock price at $18, but the option went as high as $8.
Another option I played with was a near term call in ELN, where I bought it within 1 month of expiration, and sold it the day of the close as the stock was shooting up. This was a June $20 option that I bought for as little as $.15 and sold for as high as $1.90, just a week later.
posted by indigo4963 at 9:35 AM on December 6, 2007
Response by poster: Indigo - in the TASR example, you bought january 08 options in April 07 -- an 8 month lead. Is there any advantage to buying an 8 month lead as opposed to, say, a 3 month lead? (Other than, obviously, the longer timeframe in which the underlying stock can rebound or gain in value). In other words, why did you choose 8 months as opposed to a shorter (or longer) period?
posted by jak68 at 9:39 AM on December 6, 2007
posted by jak68 at 9:39 AM on December 6, 2007
In response to indigo:
I bought an AAPL option for 120, sold for 12, and an HPQ option for 135 which sold for 35. Remember that as fast as you can make money, you can lose just as fast.
Don't get too addicted to the gambling part :)
posted by cschneid at 9:39 AM on December 6, 2007
I bought an AAPL option for 120, sold for 12, and an HPQ option for 135 which sold for 35. Remember that as fast as you can make money, you can lose just as fast.
Don't get too addicted to the gambling part :)
posted by cschneid at 9:39 AM on December 6, 2007
Response by poster: (actually anyone can answer that, not just indigo ;)
posted by jak68 at 9:40 AM on December 6, 2007
posted by jak68 at 9:40 AM on December 6, 2007
jak68, it's all about how much time you think it'll take for the underlying to move. If you are buying becuase of a fixed date good news (on a pharmaceutical for instance), it doesn't make any sense to pay all that extra money for a further out option. On the other hand, if you just think it's a great company, buying an option 2 years out might make perfect sense. It all depends on what your time frame is, and what you think is going to happen.
Also note that if you buy LEAPs (1 year+) you can get the long term capital gains on them, not so with short term options.
posted by cschneid at 9:43 AM on December 6, 2007
Also note that if you buy LEAPs (1 year+) you can get the long term capital gains on them, not so with short term options.
posted by cschneid at 9:43 AM on December 6, 2007
cschneid -- I've had my share of terrible losses, too. Overall I'm still down on the year after becoming overly excited about DNDN and ELN.
The TASR option was bought on the rumor that a new French government might be placing a large order for Taser products. It was true that one of the candidates did talk about this, and when he was elected to office, did follow through with an order.
I think the value of the long lead time, particularly with biotech stocks, is that news of a product coming to market will arrive sometime within a time frame. So it is known that the FDA will rule on the approval of a drug by a certain date. If I think it will be approved, then I'll buy OTM calls within a month of the expected date. FDA delays can kill the stock, so buying puts is a way to take advantage of a severe drop within the same time frame.
posted by indigo4963 at 9:50 AM on December 6, 2007
The TASR option was bought on the rumor that a new French government might be placing a large order for Taser products. It was true that one of the candidates did talk about this, and when he was elected to office, did follow through with an order.
I think the value of the long lead time, particularly with biotech stocks, is that news of a product coming to market will arrive sometime within a time frame. So it is known that the FDA will rule on the approval of a drug by a certain date. If I think it will be approved, then I'll buy OTM calls within a month of the expected date. FDA delays can kill the stock, so buying puts is a way to take advantage of a severe drop within the same time frame.
posted by indigo4963 at 9:50 AM on December 6, 2007
Please just bear in mind that trading options is fundamentally different from stock investing. Your unconditional expectation when you buy a stock is that you will make money, that is because a stock represents a percentage of a company's future cash flows. Your unconditional expectation for an option is at best that you will lose a little bit (because they usually are trading around fair value and you will have to pay the bid / ask spread on entry and exit and that spread is usually higher (in percentage terms) than for the same stock).
I am not saying never trade options, but I think options trading should be held to a higher standard of thought than stock trading.
posted by shothotbot at 10:01 AM on December 6, 2007
I am not saying never trade options, but I think options trading should be held to a higher standard of thought than stock trading.
posted by shothotbot at 10:01 AM on December 6, 2007
I'm just closing it out, right? Am I selling it? (I'm not writing it, right?) If i'm selling it, who would buy it, especially if there's only a couple of weeks before expiration? Why would they buy it?
Um, right. You can think of writing a call option like going short the option; you write one, your position shows up as -1. Then you have the obligation to sell the underlying at the strike price, if it gets exercised. Where you get the stock to sell in that case would be up to you and your broker.
Two people come to mind who might buy your near-expiry call option: Someone probably willing to take more risk and leverage than you are, who wants to speculate on it rising in price tomorrow. And someone probably more risk-averse than you are, who wrote the option and wants to close their position. Note that it is not uncommon for near-worthless options near expiry to have no bid at all.
You'll probably want to read about Black-Scholes. Not that you'd want to use it directly, but understanding what it does will give you some idea of what options pricing models should look like, and what you should be thinking about to make these decisions.
posted by sfenders at 10:33 AM on December 6, 2007
Um, right. You can think of writing a call option like going short the option; you write one, your position shows up as -1. Then you have the obligation to sell the underlying at the strike price, if it gets exercised. Where you get the stock to sell in that case would be up to you and your broker.
Two people come to mind who might buy your near-expiry call option: Someone probably willing to take more risk and leverage than you are, who wants to speculate on it rising in price tomorrow. And someone probably more risk-averse than you are, who wrote the option and wants to close their position. Note that it is not uncommon for near-worthless options near expiry to have no bid at all.
You'll probably want to read about Black-Scholes. Not that you'd want to use it directly, but understanding what it does will give you some idea of what options pricing models should look like, and what you should be thinking about to make these decisions.
posted by sfenders at 10:33 AM on December 6, 2007
the reason those are unlimited risk is because they are a multi-option strategy
Oops, if I'd have read closer I would have seen that you said single option strategy, sorry. :)
posted by triggerfinger at 11:06 AM on December 6, 2007
Oops, if I'd have read closer I would have seen that you said single option strategy, sorry. :)
posted by triggerfinger at 11:06 AM on December 6, 2007
shothotbot makes an important point: Options are fundamentally different than stock. Options are priced on expectation, volatility, and theta.
Your hunches and expectation of the market's behavior *must be* in advance of the rest of the market (even if you're wrong but you dump the options while other investors have similar expectations, you make money).
There must be enough volatility to make the gamble worthwhile. We live in volatile times, so this one's not too much of a challenge.
You must have enough timeliness in your forethought to make predictions far enough in advance.
The important aspect of what makes options not the same as investing is that you have to know (or believe) something *before* the rest of the market. To do this regularly you need to be omniscient, cheating, or smarter than (most) everyone else. Or just call it gambling and have fun.
posted by lothar at 11:10 AM on December 6, 2007
Your hunches and expectation of the market's behavior *must be* in advance of the rest of the market (even if you're wrong but you dump the options while other investors have similar expectations, you make money).
There must be enough volatility to make the gamble worthwhile. We live in volatile times, so this one's not too much of a challenge.
You must have enough timeliness in your forethought to make predictions far enough in advance.
The important aspect of what makes options not the same as investing is that you have to know (or believe) something *before* the rest of the market. To do this regularly you need to be omniscient, cheating, or smarter than (most) everyone else. Or just call it gambling and have fun.
posted by lothar at 11:10 AM on December 6, 2007
Lothar - Also consider that buying and selling both call and put options are part of hedging strategies against the underlying stocks. Then, one is not being omniscient, just prudent.
posted by fatllama at 2:07 PM on December 6, 2007
posted by fatllama at 2:07 PM on December 6, 2007
Response by poster: thanks everyone. I'll be careful, I promise ;) The TOS site is excellent.
posted by jak68 at 5:18 PM on December 6, 2007
posted by jak68 at 5:18 PM on December 6, 2007
This thread is closed to new comments.
posted by jak68 at 8:31 AM on December 6, 2007