How is option buying power calculated?

[safvan]

Say to there is $2500 to risk on an options trade.

Apple out of the money x number of months ahead is available to buy for $5 or $500 per 100 shares. The stock value is $300.

Another stock say symbol XYZ is trading at $50 and out the money option is available to buy for $5 or $500 per 100 shares.

How is it possible that we are able to control apple shares worth $150,000 for only $2500 (2500/500=5 contracts)

and in the other case XYZ shares worth $25,000 for also $2500.

Naturally people would like to get more expensive stocks for their $2500 investment.

Surely there has to be a limit to the buying power based on the price of the underlying stock? so the question is there one?

 

[Martinghoul]

It's a matter of probabilities... You can't compare apples (pun intended) with oranges.

 

[safvan]

Assuming you have a reasonable trading system for options. The options pricing system based on the underlying security seems to be quite complex.

Like in my example it costs the same to buy $25,000 worth of XYZ stock trading at $50 right now for $2500 and it also costs the same to buy $150,000 worth of apple stock at $300 right now for $2500.

A 10% expected move for a $300 dollar stock is a lot more than a 10% move of a $50 stock.

So basically trading low cost stocks for options is a bad idea to begin with when the outcome of profits is higher for a more expensive stock.

 

[Martinghoul]

You're looking at it completely wrong... You're not buying the stock. You're buying the possibility of owning the stock if your option expires ITM. So "cost" taken by itself is meaningless.

 

[scose-no-doubt]

delta innit?

 

[safvan]

You're looking at it completely wrong... You're not buying the stock. You're buying the possibility of owning the stock if your option expires ITM. So "cost" taken by itself is meaningless.

Makes sense.

Another question. Open interest and volume are different things.

Can we sell an option which is out of the money but still in profit (cuz we bought it cheaper) when there is no volume and open interest?

If there is no volume can our orders get executed? I assume the market maker has to honor the sale?

 

[Martinghoul]

delta innit?

Yeah, mon...

 

[Martinghoul]

Makes sense.

Another question. Open interest and volume are different things.

Can we sell an option which is out of the money but still in profit (cuz we bought it cheaper) when there is no volume?

If there is no volume can our orders get executed? I assume the market maker has to honor the sale?

Well, this a rather interesting question...

Volume is meaningless, in and of itself. The fact that nobody has traded a particular option doesn't mean that there's no mkt. The dealer will make you a mkt, but you may not like the prices you get shown. So, in theory, there's always a price. In practice, things are a bit different. Specifically, there's a good reason why far OTM options rarely trade. Firstly, it almost never makes sense to sell an OTM option. Secondly, for OTM options transaction costs as a percentage of risk/margin/PNL are significantly higher. That means that in most cases, if you're bovvered, it's better to do whatever you're looking to do by trading the underlying, rather than the option.