OTM ATM ITM option at expiration

[Gob00st]

Sorry for a option noob problem :

What the likely option value at expiration for OTM, ATM, ITM ?

Say I purchased a out of the money call $100 with a price of $20
for a equity while equity price was 80.

Then at the expiration of this option:
1> OTM
Equity price moved up to 95
option value = 0?
This should be zero as it's intrinsic & extrinsic both zero.

2>ATM
Equity price moved up to 100
option value = ?
This extrinsic is zero but how about intrinsic value ? $20 when originally purchased ?

3>ITM
Equity price moved up to 105
option value = ?
This extrinsic is zero but how about intrinsic value ? A bit more than 20 when originally purchased ?

Thanks

 

[Martinghoul]

Intrinsic value for the first two cases is 0, for the last case it's 5. The intrinsic value of an option has notning to do with the original premium paid.

 

[Gob00st]

Martin, thanks for the reply.
So this mean unless the underlying equity rise the price to $120 @ expiration, in which case, the intrinsic value of option120-100 = $20, then this is a breakeven trade. Otherwise , this is a losing trade regardless ?

 

[Martinghoul]

Indeedy... $120 is breakeven.

 

[Gob00st]

Sorry for one more question: for naked long call option, is it better to write it(sell the call) at least 2 month ahead of expiration so it could have some decent extrinsic value as well assuming it has gone from OTM to ITM at the time?

If this is true, say if I see the underlying equity will rise to a swing high say @ March 2012, then would it be more reasonable to purchase the May 2012 option rather than then march 2012 option even though the March one should be cheaper?

Can you please clarify on this one as well ?

 

[Martinghoul]

There are no hard and fast rules for any of this stuff. Don't sell call options just because you want to sell more "extrinsic" value. It's not a free lunch and it's not like you get more free lunch the more time to expiry you sell. In an overwhelming majority of cases, you get fairly compensated for the risk you're taking with the position.

For your second question, it's also very hard to give a specific answer. The whole point of options is that you don't know the future with certainty, but rather a distribution of a whole variety of possible futures. So if you know the underlying equity is going to a high in March, buy the underlying and forget about options. If you don't know, it's very hard to say which of the two option expiries is better, because it's certainly not a simply function of a higher or lower premium amount. Premium, by itself, is a meaningless number.

 

[Gob00st]

Martin, I have been trying to treat option as a margin tool, that's one reason I am trading option rather than the underlying equity.

I thought if I can timing good, option should maximum the profit with limited risk. I had briefly studied option greeks and B-S modal, but I am not sure how to really utilized B-S modal to help me make decision :which option is better.

Could you recommend a few good article/books for new option trader like me ?
I mainly doing naked call/put. Maybe this is a mistake already ?

There are no hard and fast rules for any of this stuff. Don't sell call options just because you want to sell more "extrinsic" value. It's not a free lunch and it's not like you get more free lunch the more time to expiry you sell. In an overwhelming majority of cases, you get fairly compensated for the risk you're taking with the position.

For your second question, it's also very hard to give a specific answer. The whole point of options is that you don't know the future with certainty, but rather a distribution of a whole variety of possible futures. So if you know the underlying equity is going to a high in March, buy the underlying and forget about options. If you don't know, it's very hard to say which of the two option expiries is better, because it's certainly not a simply function of a higher or lower premium amount. Premium, by itself, is a meaningless number.

 

[Martinghoul]

Martin, I have been trying to treat option as a margin tool, that's one reason I am trading option rather than the underlying equity.

I thought if I can timing good, option should maximum the profit with limited risk. I had briefly studied option greeks and B-S modal, but I am not sure how to really utilized B-S modal to help me make decision :which option is better.

Could you recommend a few good article/books for new option trader like me ?
I mainly doing naked call/put. Maybe this is a mistake already ?

Nothing is necessarily a mistake and nothing is going to offer you a "better" way to make money. There are no rights or wrongs. You just need to be careful and think about the possible outcomes. For that you don't need articles/books. All you need is Excel (or one of the free option tools available on the web). Once you have access to that and before you get into any trades, try to look at what happens to your money under different scenarios. Are you comfortable with the sorts of losses that you're likely to experience if the underlying moves the wrong way?

If you want to then get into deeper subjects, e.g. Greeks etc, read one of the very well-known options books, such as Natenberg or Hull or Sinclair.

Feel free to ask questions. Be careful out there and good luck!

 

[Gob00st]

Martin, thanks for pointing the way. Could you please PM me a copy of the free excel tool so I can start play with it ?

 

[Martinghoul]

I would suggest using one of the online pricers, rather than a free Excel sheet (although you can find plenty of those). Try smth like this: Option Price Calculator

If you Google, you will find more stuff and it might be a lot more fancy. For example, this: The Options Lab for serious options trader (although I am not sure if it's properly free).

 

[Gob00st]

Martin thanks for the links.

I would suggest using one of the online pricers, rather than a free Excel sheet (although you can find plenty of those). Try smth like this: Option Price Calculator

If you Google, you will find more stuff and it might be a lot more fancy. For example, this: The Options Lab for serious options trader (although I am not sure if it's properly free).

 

[Petrescu]

I recommend reading the Sheldon book on options. I started out focusing on direction, and that book opened my eyes to volatility. If you're curious to see how volatility is similar to time just read the book.

 

[Gob00st]

Petrescu, I am relative new to option trading, is Sheldon's book <Option Volatility & Pricing: Advanced Trading Strategies and Techniques > too fancy for a option beginner ? Or it's ok for a beginner too ?
If not could you recommend some entry level option book for me ?

But you are definitely right as I am still focusing on direction as I trade stocks and futures too !
I really need to get my mind use to all the option Greeks specially volatility !

 

[Petrescu]

It's perfect for the beginner. You can just save the chapters on spreads for when you are more experienced. I read the first few chapters and the chapter on volatility 3 times. It gives The reader a great conceptual grasp of the complex issues. The book has very many graphs not found in other books.

 

[Gob00st]

:clap:Thanks Petrescu ! Actually I have already got the book after googling it !

I have done a few option trade before & some of them worked out really well like 50% profit in a few days !

But there was one trade I got the underlying direction right but I lost the trade bcos of volatility ... That striked me that option is not future or stock... Totally different animal... I hope I understand option volatility more before I place the trade.

It's perfect for the beginner. You can just save the chapters on spreads for when you are more experienced. I read the first few chapters and the chapter on volatility 3 times. It gives The reader a great conceptual grasp of the complex issues. The book has very many graphs not found in other books.