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#1
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I'm reading up on stock options and had the following question I thought someone could explain.
If I purchase a call option, I know that the break-even point is strike price + option price. E.g. if the strike is $100 and the option premium is $2, then I'll profit as long as the stock goes above $102. My question? Does the option premium rise or fall proportionally with stock price? I ask b/c I'm following a call purchase (paper only) and I notice that if I were to just sell the option today, I would profit. However, if I were to actually exercise the option (buy and sell the stock), I'd be loser. Here's the scenario: 5 contracts of May SPY 140 (Call) at an option price of 3.9. At the close of market today, SPY is at 142.16 but the option price is 4.76. So, if today were expiration, I'd be loser if I exercised and bought/sold the stock but winner if I just sold the option. Am I missing something? It seems that in all the books, websites I've read, I profit or lose the same amount regardless of how I close out the transaction. Are they just making the math easier? Thanks in advance and no worries, no real trading yet!! |
#2
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http://en.wikipedia.org/wiki/Option_time_value
The graph on the right will be good for you to look at. The main takeaways: 1) Yes the option value does increase as the asset value increases. 2) Your example is a perfect example for why it is almost never correct to exercise an option early. The reason for this is basically (assuming volatility hasn't changed) that there is still time for the stock to move yet higher than it is currently. |
#3
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[ QUOTE ]
http://en.wikipedia.org/wiki/Option_time_value The graph on the right will be good for you to look at. The main takeaways: 1) Yes the option value does increase as the asset value increases. 2) Your example is a perfect example for why it is almost never correct to exercise an option early. The reason for this is basically (assuming volatility hasn't changed) that there is still time for the stock to move yet higher than it is currently. [/ QUOTE ] Yay! I did pick up on something in my reading. So as I get closer to expiration, the value of selling the option as compared to exercising the rights would get closer to equal, correct? Thanks much!! |
#4
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As stated above its almost never correct to early exercise an option barring a dividend or other special circumstance. Delta is the measure of how the option and underlying move together, higher delta=higher the correlation between the option price movement and a movement in the underlying.
You are correct the closer you get to expiration all other factors being equal the option premium should decay, this is measured by theta. |
#5
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#6
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in plain english, dont exercise it early because the option's value is composed of:
its time value + if the option is "in the money" exercising early gives up time value. however, if you believe that the price is going to fall, instead of exercising the option, sell it in the secondary market. you will get its intrinsic and time value. |
#7
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[ QUOTE ]
So as I get closer to expiration, the value of selling the option as compared to exercising the rights would get closer to equal, correct? [/ QUOTE ] Correct. (This also happens as the option gets deep in the money.) The time decay really kicks in during the last month. For this reason I never own options with less than a month to go, though I have often been short near-to-expiration options. |
#8
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for reasonably liquid options its always possible to sell them post-expiration when they are in the money rather than exercise them right? assuming you are buying options for the leverage and you don't have the money required to actually exercise it.
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#9
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Liquidity can change with the value of the stock. Last year I bought $12.50 puts on a stock trading at $14. They were reasonably liquid for a mid-cap stock, with bid/ask spreads of 6% or so. Within a couple months, the rest of the market realized what a piece of crap it was, and it dropped to $4. At this point, no one wanted to trade options that were so far into the money, so the liquidity dried up. If I had tried to sell the puts, I would have gotten less than their exercise value.
To exit the position, what I did was buy the stock. This gave me the same profits as if I had exercised, with additional upside if the stock charged back up above $12.50. |
#10
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[ QUOTE ]
for reasonably liquid options its always possible to sell them post-expiration when they are in the money rather than exercise them right? [/ QUOTE ] No, post-expiration a long call [put] either expires worthless or is exercised and you have to pay for [deliver] the underlying instrument, except those which simply settle to cash. There's no trade in an option once it expires. |
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