Newbie Options Trading

[Jonathan Hewitt]

Thank you. one more follow up -

If I all I want to do is exercise an option and then sell at market price, do I need to have the full cash value of the strike price * number of shares on hand? or I can simultaneously buy at strike and sell at market without having to front the cash?

The only reason to do this that I can think of would be if there's so little time value left that you would lose more money on the Bid/Ask spread than the amount of time value left.

However, by waiting until execution you now subject yourself to additional risk as the stock could be worth much less on the execution day than it is today negating any potential gain you could have had selling the options today. You also have to look at transaction costs as you will have to pay a brokerage fee for option assignment and then another commission when you sell the stock. Depending on your brokerage and transaction size this could either not be a big deal or it could be a decent chunk of change if you're doing small time trading.

 

[avatar]

Hi Thank you for your response. That's not what I meant. I want to simply exercise an option. Since exercising an option involving buying at strike and (if desired) selling at market price, I want to know if I need cash to execute the first half of the transaction or if the brokerage will allow both transactions without cash in hand. I am assuming here that the underlying equity appreciates from the strike.

 

[ggr]

I could have sworn that I already answered your question. Yes, you need the buying power (cash or margin).

Perhaps you're being confused by employee stock option grants, where there is often a "cashless exercise". But these are completely different things, not what we're talking about here.

 

[MikeC]

Hi Thank you for your response. That's not what I meant. I want to simply exercise an option. Since exercising an option involving buying at strike and (if desired) selling at market price, I want to know if I need cash to execute the first half of the transaction or if the brokerage will allow both transactions without cash in hand. I am assuming here that the underlying equity appreciates from the strike.

I believe exercising the option just means buying the shares at the strike price. Selling the shares later is just selling the shares. What people have already recommended is to just sell the call, which will give you the same result as exercising and then selling without requiring that you have the money to pay for the shares. Plus you'll end up with a little more because of the time premium. So I think people are confused why you would want to go through the extra hassle instead of just selling the call.

 

[CyberDutchie]

I believe exercising the option just means buying the shares at the strike price. Selling the shares later is just selling the shares. What people have already recommended is to just sell the call, which will give you the same result as exercising and then selling without requiring that you have the money to pay for the shares. Plus you'll end up with a little more because of the time premium. So I think people are confused why you would want to go through the extra hassle instead of just selling the call.

The common reason for exercising versus selling the call is tax consequence. When you sell a call and make a profit, you have to pay taxes over the gain (not true with an IRA account though). When you exercise the call, you own the shares and only have to pay taxes when you eventually sell them at a profit. What you paid for the call (called premium or time value) gets added to the strike price and becomes the cost basis for the shares you now own.

 

[ggr]

The common reason for exercising versus selling the call is tax consequence. When you sell a call and make a profit, you have to pay taxes over the gain (not true with an IRA account though). When you exercise the call, you own the shares and only have to pay taxes when you eventually sell them at a profit. What you paid for the call (called premium or time value) gets added to the strike price and becomes the cost basis for the shares you now own.

What you say is true, but doesn't apply to the question asked, which said "... and sell them immediately". Yes, if there's a lot of capital gains on the options it may well be worth doing exercising and holding. But not exercising and selling.

 

[avatar]

Hi - I think I understand the point now. This was the missing piece in my head for me:

"Selling the shares later is just selling the shares. What people have already recommended is to just sell the call, which will give you the same result as exercising and then selling without requiring that you have the money to pay for the shares"

Thank you.

 

[Muskol]

I posted my TSLA war story in the 2014 war story thread, thought it would be appropriate to post here as well.

2014 Trading War Stories - Page 2

 

[MikeC]

Anyone have experience with calendar spreads?

Because of the high ER implied volatility, there is not a lot of price difference in the May8 calls compared to the same strike May15 calls. I sold a May8 210 and bought a May15 210 last week basically for a net cost of $100. On May 8th, I'll close out both positions.

It seems like minimal risk to the downside, I'm just not sure what potential upside I might hope to expect.

 

[InTheShadows]

Anyone have experience with calendar spreads?

Because of the high ER implied volatility, there is not a lot of price difference in the May8 calls compared to the same strike May15 calls. I sold a May8 210 and bought a May15 210 last week basically for a net cost of $100. On May 8th, I'll close out both positions.

It seems like minimal risk to the downside, I'm just not sure what potential upside I might hope to expect.

I would love to hear about this too. Although this is probably not a newbie question and should be in the advanced thread.

I have considered these before and now after your comment, taking a second look and seeing a debit of $1 for an ATM spread seems like a pretty good deal.

Would the apr 30th announcement add to the volatility to make it an even better return?

Since I have never done this trade I have a few questions.

Is it usually best to close this out right before the announcement?

What happens if you hold through ER?

Is there an advantage to legging into this?

What happens if you hold to a date between the expiration a?

How do you figure max risk and max gain by holding through ER.

 

[mershaw2001]

Anyone have experience with calendar spreads?

Because of the high ER implied volatility, there is not a lot of price difference in the May8 calls compared to the same strike May15 calls. I sold a May8 210 and bought a May15 210 last week basically for a net cost of $100. On May 8th, I'll close out both positions.

It seems like minimal risk to the downside, I'm just not sure what potential upside I might hope to expect.

I'm curious to hear how this is profitable and where your exit points would be. It seems like it has a lot of potential but let me lay out my thoughts and you can tell me where you see the opportunity.
1) if earnings are a success and the price is (to take it to an extreme) 250 dollars, both options are in the money equally because they are both deep in the money the cost you paid for the extra week is negligible and the difference in the two option prices goes to zero, losing you 100 dollars.
2) If earnings are a bust and the price stays the same near 210 or drops some, the may 8th call goes to zero really quickly but the may 15th call retains time value, meaning you can profit by closing the position on may 8th. The profit though is the value of the extra week, which is probably slightly over 100 dollars but not by much. Alternatively, you could close the may 8th one and keep the may 15th hoping for the price to rise.

What other situations are there?

 

[MikeC]

I'm curious to hear how this is profitable and where your exit points would be. It seems like it has a lot of potential but let me lay out my thoughts and you can tell me where you see the opportunity.
1) if earnings are a success and the price is (to take it to an extreme) 250 dollars, both options are in the money equally because they are both deep in the money the cost you paid for the extra week is negligible and the difference in the two option prices goes to zero, losing you 100 dollars.
2) If earnings are a bust and the price stays the same near 210 or drops some, the may 8th call goes to zero really quickly but the may 15th call retains time value, meaning you can profit by closing the position on may 8th. The profit though is the value of the extra week, which is probably slightly over 100 dollars but not by much. Alternatively, you could close the may 8th one and keep the may 15th hoping for the price to rise.

What other situations are there?

My theory is that IV is greater for May 8 than May 15 and so with post-ER IV crush May 8 may lose more value, allowing me to close both positions on May 8 (assuming the share price is over the strike price). If the spread widens to, say, $1.50 that would be a 50% gain. But I don't know what a week of time value would actually be worth at that point.

 

[InTheShadows]

I'm curious to hear how this is profitable and where your exit points would be. It seems like it has a lot of potential but let me lay out my thoughts and you can tell me where you see the opportunity.
1) if earnings are a success and the price is (to take it to an extreme) 250 dollars, both options are in the money equally because they are both deep in the money the cost you paid for the extra week is negligible and the difference in the two option prices goes to zero, losing you 100 dollars.
2) If earnings are a bust and the price stays the same near 210 or drops some, the may 8th call goes to zero really quickly but the may 15th call retains time value, meaning you can profit by closing the position on may 8th. The profit though is the value of the extra week, which is probably slightly over 100 dollars but not by much. Alternatively, you could close the may 8th one and keep the may 15th hoping for the price to rise.

What other situations are there?

I think the idea is to close out the position before earnings. Looking at this options calculator chart it looks like the risk factor is pretty low. However I have never done one of these before so I am going to test this with one contract.

Sorry I had to do this in two screen grabs. Use the strike like to line them up.


UPDATE: just noticed I can generate a short link to the chart.

TSLA Calendar Spread calculator

 

[mershaw2001]

Thanks for doing this! One thing that i might criticize is that the program optionsprofitcalculator assumes that IV remains constant throughout the duration of the option life. This is what gives the outcome at 220 such a great reward- if the stock price is 220 on may 8th, then the 220 short contract expires worthless but with the high IV and 1 week time, the price of the 220 long is over 5 dollars! However, in reality there will be an IV crush following the earnings call. If the conference call wasn't so great, and tesla didn't move at all and ended at 220 on the friday after the earnings call, would people pay 5 dollars for an option contract with a 1 week lifespan? I don't think that any of us can give an accurate answer to that, we could speculate though, and that speculation is going to be what makes you decide to take this trade. I think it's a good chance that the value of a 1 week at the money option will be above 100 dollars (your cost) so it seems worth it! However, getting that money comes with taking the risk of the stock being over 240 dollars. If it's over 240, the position is worth 30 dollars and you lost 70 dollars of your initial investment.

Similarly if the price is around 204, your option position is worth 65 bucks but you paid 100, so you're net -35.

Thank you for the chart and thanks for letting me ramble, it helped me think through it. You need have the following conditions occur to profit. 1) price has to end between 204 and 240 on the day after earnings. 2) implied volatility must remain high enough so that the price of a 1 week at-the-money call is greater than your initial net debit.

Point number 2 seems like a yes, but you're capped at how much profit you can make.

Maybe i'll take a shot at this, i do wish i had the ability to retrospectively see how this strategy would have worked after the last few earnings calls. Again, this options calculator can't take into account the IV crash that is inherent in the weeklies following the earnings report.

 

[InTheShadows]

Thanks for doing this! One thing that i might criticize is that the program optionsprofitcalculator assumes that IV remains constant throughout the duration of the option life. This is what gives the outcome at 220 such a great reward- if the stock price is 220 on may 8th, then the 220 short contract expires worthless but with the high IV and 1 week time, the price of the 220 long is over 5 dollars! However, in reality there will be an IV crush following the earnings call. If the conference call wasn't so great, and tesla didn't move at all and ended at 220 on the friday after the earnings call, would people pay 5 dollars for an option contract with a 1 week lifespan? I don't think that any of us can give an accurate answer to that, we could speculate though, and that speculation is going to be what makes you decide to take this trade. I think it's a good chance that the value of a 1 week at the money option will be above 100 dollars (your cost) so it seems worth it! However, getting that money comes with taking the risk of the stock being over 240 dollars. If it's over 240, the position is worth 30 dollars and you lost 70 dollars of your initial investment.

Similarly if the price is around 204, your option position is worth 65 bucks but you paid 100, so you're net -35.

Thank you for the chart and thanks for letting me ramble, it helped me think through it. You need have the following conditions occur to profit. 1) price has to end between 204 and 240 on the day after earnings. 2) implied volatility must remain high enough so that the price of a 1 week at-the-money call is greater than your initial net debit.

Point number 2 seems like a yes, but you're capped at how much profit you can make.

Maybe i'll take a shot at this, i do wish i had the ability to retrospectively see how this strategy would have worked after the last few earnings calls. Again, this options calculator can't take into account the IV crash that is inherent in the weeklies following the earnings report.

That is why I think I will be trying this, however I will be closing it the day of earnings before market close so that I max out the iv factor.

At least that is the plan.

The risk/reward drops off massively if it's held through earnings. Using the calculator and say we are still at 220 (which I highly doubt) to give up on a 5-6 bagger to get attempt to maximize it for another 200% in theory makes selling before earnings a no brainer.

I picked 220 because for this to work well the research I have done says liquidity is a must. So picking a strike with high volume and open interest is key.

I will try it in my paper account with aapl. However aapl' ER is mondsy which isn't as good. From what I read wed or Thursday ER's are the best.

 

[mershaw2001]

But the short option won't decay in value linearly, like it does according to Option calculator. My experience is that options climb in value despite time ticking away as it gets closer to earnings. Then Market closes, announcement comes, and IV drops to nothing when the market opens the next day. The reason you're finding a "misspricing" in the option chain (with the May8th nearly equal to the may 15ths) is that those may 8ths will retain their value right up until the market closes on the earnings day. Just something to consider!

 

[Blip]

I believe the best way to use calendar spreads, is to let the short position expire before ER, and sell the long at the same time. Calendars should be used when IV is low and expected to increase. This will increase value of long leg, but hopefully expire worthless on the short.

You could also try a double calendar. Its like a "saggy" Iron Condor...

 

[sub]

I've got a question for you guys regarding delayed construct spreads. Right now I've got shares and leaps in TSLA but have an idea on how to create spreads with the leaps to lock in some profits, looking for others to poke holes in my thought process.

Example (not my real positions): Let's say on this last dip I bought a J17 150 strike call for $7500 while stock price was at $190. With the Stock price now up around $30 from there, I could sell this leap for ~2k profit, or, I could sell a J17 strike 180 call to make it a risk free spread. If TSLA closes above 180 at expiration I make 3k instead of taking the 2k now. I could then immediately buy another leap and repeat. It seems that this would lock in some profits above 180, allow me to buy back that 180 call on short term dips then resell again, yet I still get to take advantage of all the upside by immediately buying another leap. I think this would also supercharge returns.

These numbers are all made up so don't verify using option chain, but they are close enough to make the point. I'm not seeing any down side of this vs just holding leaps, I still end up with one long call leap but manage to lock in a risk free spread along the way that reduces my risk. If you did this with leaps really deep in the money under $100, TSLA would have to almost fail as a company for the stock price to drop low enough to endanger the spreads. Please poke holes in my idea if you see them, I feel like I must be missing something.

 

[mershaw2001]

I've got a question for you guys regarding delayed construct spreads. Right now I've got shares and leaps in TSLA but have an idea on how to create spreads with the leaps to lock in some profits, looking for others to poke holes in my thought process.

Example (not my real positions): Let's say on this last dip I bought a J17 150 strike call for $7500 while stock price was at $190. With the Stock price now up around $30 from there, I could sell this leap for ~2k profit, or, I could sell a J17 strike 180 call to make it a risk free spread. If TSLA closes above 180 at expiration I make 3k instead of taking the 2k now. I could then immediately buy another leap and repeat. It seems that this would lock in some profits above 180, allow me to buy back that 180 call on short term dips then resell again, yet I still get to take advantage of all the upside by immediately buying another leap. I think this would also supercharge returns.

These numbers are all made up so don't verify using option chain, but they are close enough to make the point. I'm not seeing any down side of this vs just holding leaps, I still end up with one long call leap but manage to lock in a risk free spread along the way that reduces my risk. If you did this with leaps really deep in the money under $100, TSLA would have to almost fail as a company for the stock price to drop low enough to endanger the spreads. Please poke holes in my idea if you see them, I feel like I must be missing something.

Your strategy for "buy another leap and repeat" requires the stock price to go down. If the price keeps on going up, you lost out on potential profit. If you would buy the long leg at the current prices, you're just buying a spread by doing it in conjunction with the short 180 leap.

 

[CaptainKirk]

@sub if you got LEAP at a fair price, isn't it better to sell a covered call when the shares approach ATH? I recall another member suggesting this as a newbie strategy. If and when the stock breaks ATH again, it likely will still be volatile and you can close the call then and lock in profit on the pullback. Why not wait a bit if you think Tesla can execute?