Newbie Question: Am I completely wrong?

[dkong]

Hi all,

I am a complete newbie at options . So, I just want to run a trade by you guys to see if what I am saying is right:

I am expecting GE to be around $20 by Jan 2012, so I'm thinking of buying a CALL option with a strike price of $17.50.

Currently, the asking price is $0.92.
Say, I bought 10 contracts, that will cost me $920 + commission.

So, my maximum loss will be $920 + commission and my breakeven price is $17.50 + $0.92 = $18.42

Let's say in Jan 2012, the price is $20, so my profits will be:
( $20 - $18.42 = $1.58 ) x 1000 = $1580

Is there anything else I should know that might happen between now & Jan 2012 that might affect the value of the contract?

Many thanks!

- dkong

 

[QuestOptions]

Hi all,

I am a complete newbie at options . So, I just want to run a trade by you guys to see if what I am saying is right:

I am expecting GE to be around $20 by Jan 2012, so I'm thinking of buying a CALL option with a strike price of $17.50.

Currently, the asking price is $0.92.
Say, I bought 10 contracts, that will cost me $920 + commission.

So, my maximum loss will be $920 + commission and my breakeven price is $17.50 + $0.92 = $18.42

Let's say in Jan 2012, the price is $20, so my profits will be:
( $20 - $18.42 = $1.58 ) x 1000 = $1580

Is there anything else I should know that might happen between now & Jan 2012 that might affect the value of the contract?

Many thanks!

- dkong

your break-even points are correct. This strategy offers you limited risk and unlimited profit potential.

If you are new to options I would not suggest holding the contracts through expiration unless you don't mind having 1000 shares.

When selecting your strike make sure there is liquidity around it. If liquidity is weak then you will have a wide bid/ask spread.

Compare it to volume and open interest amongst the other strikes.

Since this is a directional trade it is important that you know where volatility is. If volatility drops on the call side than that is going to make your option worth less all things being equal.

 

[anley]

The trouble is with your trade is that you're buying option vol when it's at an extremely high price. Do you understand this concept? If not then you shouldn't really be going anywhere near options, you're better off buying the stock.

In effect if you were to buy the option you'd have 2 seperate trades on, long vol and long upside direction. What you might find is you get the direction right but the volatility collapses on you and you might even lose money, even though you were right.

Summary: Buying call options AFTER or DURING a big dump is highly risky, although you cannot lose more than the price of the option. The high risk part comes from the odds of the trade working which are probably 15% at best.

 

[dkong]

I understand as volatility increases the premium becomes larger.

however in this case, at $0.92 it is still relatively cheap right?

 

[QuestOptions]

You have to understand the nature of your product and its skew structure. Does Implied volatility rise as the underlying drops in price or does it rise when the underlying rises in price?

A common practice is to compare historical volatility to implied volatility. There are more sophisticated methods but this is a good start for a beginner.

In the case with equity options, volatility drops as the stock rises(not always though). What is "cheap" is a matter of opinion. That's what makes markets. Someone else might think that option is expensive and would be willing to sell it to you.

In most cases for equities (not always) volatility is higher on the puts than in the calls. Volatility also various amongst strike price.

The option you are referring to is an out of the money option. The only thing that gives it value is the probability factor. The chance that it could possibly go in the money. If today was hypothetically expiration the option would expire worthless.

So you were able to calculate your break-even points correctly. So you have a decent idea of what kind of move you need to see.

What is cheap or expensive is totally based on your views and opinion.

 

[Martinghoul]

Hi all,

I am a complete newbie at options . So, I just want to run a trade by you guys to see if what I am saying is right:

I am expecting GE to be around $20 by Jan 2012, so I'm thinking of buying a CALL option with a strike price of $17.50.

Currently, the asking price is $0.92.
Say, I bought 10 contracts, that will cost me $920 + commission.

So, my maximum loss will be $920 + commission and my breakeven price is $17.50 + $0.92 = $18.42

Let's say in Jan 2012, the price is $20, so my profits will be:
( $20 - $18.42 = $1.58 ) x 1000 = $1580

Is there anything else I should know that might happen between now & Jan 2012 that might affect the value of the contract?

Many thanks!

- dkong

No, you're correct on everything you say, assuming that the only thing that matters to you is terminal value. If you care about mark-to-market, there's a whole lot of other stuff that can happen.

 

[dkong]

QuestOptions, anley, Martinghoul - thank you very much for taking time to reply.

It is much appreciated!

 

[anley]

I understand as volatility increases the premium becomes larger.

however in this case, at $0.92 it is still relatively cheap right?

I doubt it's cheap, in fact I'd reckon due to the 10%-20% fall in the overall markets options are probably the most expensive they're been for a couple of years.

 

[DailyTA]

Now for the real fun... You can sell a call option each month where you don't think GE will be. This is called a long diagonal. Doing this gives you some income against your long term option. If played right, you can wind up owning the long term option for free. Tweet me with any additional questions: @DailyTA_com

 

[safvan]

Hi all,

I am a complete newbie at options . So, I just want to run a trade by you guys to see if what I am saying is right:

I am expecting GE to be around $20 by Jan 2012, so I'm thinking of buying a CALL option with a strike price of $17.50.

Currently, the asking price is $0.92.
Say, I bought 10 contracts, that will cost me $920 + commission.

So, my maximum loss will be $920 + commission and my breakeven price is $17.50 + $0.92 = $18.42

Let's say in Jan 2012, the price is $20, so my profits will be:
( $20 - $18.42 = $1.58 ) x 1000 = $1580

Is there anything else I should know that might happen between now & Jan 2012 that might affect the value of the contract?

Many thanks!

- dkong

As long as it expires in the money you should be fine.