Help me understand options

[andy9775]

So I have read a little bit about options and I just want to confirm that I understand this correctly. I have always been interested but I never really gave it a serious look. Also I am a total newb to options, traded fx and stocks with a bit of futures so be kind.
Lets use MSFT as an example using the thinkorswim platform,
Last stock price is 28.60 and it closed on the 18th at 28.40

Lets say I think that it will go down, I buy 10 puts strike @28 expire jun '10 at 0.67 for a total of $694 with commissions. Lets assume that the stock drops to $24 prior to expiry and I decide to exercise thus my profit should be,
10 contracts @ 28 sold for 28 000 current market price of 24 000.
Total profit being 4 000-694=$3 306

Am I correct to assume this?
Is there anything else I am missing?
I read that options trading can be risky but I assume that applies to selling of options?
Also once the option comes close to expiry is there an affect on my profits (when exercising the option or is time decay not a factory when exercising) or does that only come in when trying to buy/sell (when buying closer to expiry the price is higher/lower for the option)?
Also what if there is no volume at $24 will my order get processed?
Finally who takes the loss of my trade and how much do they lose?
Thanks

 

[Rhody Trader]

Lets say I think that it will go down, I buy 10 puts strike @28 expire jun '10 at 0.67 for a total of $694 with commissions. Lets assume that the stock drops to $24 prior to expiry and I decide to exercise thus my profit should be,
10 contracts @ 28 sold for 28 000 current market price of 24 000.
Total profit being 4 000-694=$3 306

Firstly, it will almost always behoove you to sell your options rather than excercise them because there will, at a minimum, be time value remaining which you will not get back if you exercise.

I read that options trading can be risky but I assume that applies to selling of options?

If you're definition of risk includes probability of losing money, then even long option positions are risky. They just clearly define how much of a loss you are limited to taking.

Also once the option comes close to expiry is there an affect on my profits (when exercising the option or is time decay not a factory when exercising) or does that only come in when trying to buy/sell (when buying closer to expiry the price is higher/lower for the option)?

Time decay is always acting against the value of a long option position.

Also what if there is no volume at $24 will my order get processed?

You may find that you're fill is at a lower price or is split over multiple price points if the volume is thin.

Finally who takes the loss of my trade and how much do they lose?

No way of knowing for sure. It depends on the position of the person on the other side of your position.

 

[andy9775]

Firstly, it will almost always behoove you to sell your options rather than excercise them because there will, at a minimum, be time value remaining which you will not get back if you exercise.

Do you mean sell options as in sell back the options that I purchased to get out of the position or do you mean sell options in the first place instead of buying a put? Also when exercising how much affect does time value have (would exercising and not selling reduce my profit by lets say 10,20,30 dollars or more like a few hundred)? I though that when exercising when the share price is at 24 it means that I make the difference of 28 to 24 equivalent to selling 1000 shares at 28 and buying back at 24. Is the profit not based on the difference in the underlying stock price?
As for my question about risk there is nothing else that comes into play other then the original purchase price of 694 correct?
What about my profit calculations, are they correct?
Thanks for the reply.

 

[Straddle8]

Finally who takes the loss of my trade and how much do they lose?
Thanks

The guy who sold you the puts, I guess.

 

[dealer911]

Do you mean sell options as in sell back the options that I purchased to get out of the position or do you mean sell options in the first place instead of buying a put? Also when exercising how much affect does time value have (would exercising and not selling reduce my profit by lets say 10,20,30 dollars or more like a few hundred)? I though that when exercising when the share price is at 24 it means that I make the difference of 28 to 24 equivalent to selling 1000 shares at 28 and buying back at 24. Is the profit not based on the difference in the underlying stock price?
As for my question about risk there is nothing else that comes into play other then the original purchase price of 694 correct?
What about my profit calculations, are they correct?
Thanks for the reply.

I think he meant sell the options that you are long - whatever you do you do not want to short options as a newbie!

 

[Rhody Trader]

Do you mean sell options as in sell back the options that I purchased to get out of the position or do you mean sell options in the first place instead of buying a put?

I mean sell into the market the options you own.

Also when exercising how much affect does time value have (would exercising and not selling reduce my profit by lets say 10,20,30 dollars or more like a few hundred)?

It depends on too many variables (time, volatility, price of the underlying, etc.) to be able to quantify easily.

I though that when exercising when the share price is at 24 it means that I make the difference of 28 to 24 equivalent to selling 1000 shares at 28 and buying back at 24. Is the profit not based on the difference in the underlying stock price?

You are correct. If you own a 24 call and the underlying price goes to 28 you can exercise to buy the stock at 24 and turn around and sell it into the market at 28. What I'm saying, though, is that the option will have a market value in excess of 4. It could be 4.10, or 5, or 10 depending mainly on the aforementioned variables. As a result, by selling the option you get more than just the 4 point difference between 24 and 28.

As for my question about risk there is nothing else that comes into play other then the original purchase price of 694 correct?

Well, obviously there is the probability of the option falling in value or becoming worthless which is part of the risk equation, but if you are long an option you cannot lose more money than you put into it.

 

[rathcoole_exile]

i'm looking forward to you taking the other side of my trades, for you patently know zip

 

[pssonice]

just one sentence to your q. : the derivative instrument isn t moving the instrument

.

 

[andy9775]

i'm looking forward to you taking the other side of my trades, for you patently know zip

Thats why if you read the first post I mentioned that I never traded options and know nothing about them and the purpose of my post is to increase my knowledge from zip to some. Reading is useful, you should try it sometime.

 

[andy9775]

You are correct. If you own a 24 call and the underlying price goes to 28 you can exercise to buy the stock at 24 and turn around and sell it into the market at 28. What I'm saying, though, is that the option will have a market value in excess of 4. It could be 4.10, or 5, or 10 depending mainly on the aforementioned variables. As a result, by selling the option you get more than just the 4 point difference between 24 and 28.

I see, so based on my profit calculations I would theoretically make $3 306 if I were to exercise but could possibly make more if I were to sell the option back correct? Also based on my understanding of time decay, the closer we get to expiration to lower the profit. Thus if for 7 days coming into expiration stock price stayed at 24 as an example, selling the option on day 7 can make me 4.30 vs selling 1 day prior I can make 4 correct?
Also as we get closer to expiry the positive time value decays and option position is just worth its intrinsic value of $4 thus theoreticly of the underlying price of the stock continues to trade at 24 the potition cant be worth less then a $4 profit (minus commissions of course) as time value cant have a negative impact on the position correct?

 

[rathcoole_exile]

Thats why if you read the first post I mentioned that I never traded options and know nothing about them and the purpose of my post is to increase my knowledge from zip to some. Reading is useful, you should try it sometime.

the point I was trying to emphasise is that a forum like T2W is okay to ask a quick question, make suggestions, get some feedback etc.

But do not attempt to educate yourself about Options solely through a message board.
It is such a complex arena that it takes months, if not years, of serious study and application to master.

So go off and buy some books and do some grunt work.

Then you'll find that most of your basic questions like above will have been answered -
only to be replaced by much more complicated, head-spinning questions.

Meanwhile, the real point I was trying to make, to help you, was do not even consider trading any money on Options while you are still in this state of darkness.

And, any more smart-alec comments from you and I'll put a black&decker through your kneecaps son, so wind your neck in.

 

[andy9775]

the point I was trying to emphasise is that a forum like T2W is okay to ask a quick question, make suggestions, get some feedback etc.

But do not attempt to educate yourself about Options solely through a message board.
It is such a complex arena that it takes months, if not years, of serious study and application to master.

So go off and buy some books and do some grunt work.

Then you'll find that most of your basic questions like above will have been answered -
only to be replaced by much more complicated, head-spinning questions.

Meanwhile, the real point I was trying to make, to help you, was do not even consider trading any money on Options while you are still in this state of darkness.

And, any more smart-alec comments from you and I'll put a black&decker through your kneecaps son, so wind your neck in.

Who said I was getting my sole education on a forum. Just asking a few questions thats all, trying to get an understanding of the basic concepts.

 

[Rhody Trader]

I see, so based on my profit calculations I would theoretically make $3 306 if I were to exercise but could possibly make more if I were to sell the option back correct?

Right.

Also based on my understanding of time decay, the closer we get to expiration to lower the profit. Thus if for 7 days coming into expiration stock price stayed at 24 as an example, selling the option on day 7 can make me 4.30 vs selling 1 day prior I can make 4 correct?

It is incorrect to say "the closer..the lower the profit". More correctly would be "the lower the time value" because there are other factors in the option price. All else holding equal, however, the price of an option will gradually decline toward intrinsic value (stock price - strike price for a call) as expiration approaches.

Also as we get closer to expiry the positive time value decays and option position is just worth its intrinsic value of $4 thus theoreticly of the underlying price of the stock continues to trade at 24 the potition cant be worth less then a $4 profit (minus commissions of course) as time value cant have a negative impact on the position correct?

I would call time decay a negative rather than a positive since it reduces the value of the option, but i think I know what you're asking. Intrinsic value is the lowest an option value will go.

 

[andy9775]

I would call time decay a negative rather than a positive since it reduces the value of the option, but i think I know what you're asking. Intrinsic value is the lowest an option value will go.

yes what I meant was time value could never take away from the intrinsic value. Thanks for the help.

 

[DHB]

If you really want to learn about trading options, you should read Option Volatility & Pricing - Advanced Trading Strategies and Techniques, by Sheldon Natenberg.

 

[Risk it fora Biscuit]

'And, any more smart-alec comments from you and I'll put a black&decker through your kneecaps son, so wind your neck in.'

Ha, I thought those days in our 'wee' (pffft) country were long gone until the other night.