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Ryan Takach
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I am an individual investor with over eight years trading experience in equities and options. I hold an MBA from the Kellstadt Graduate School of Business at DePaul University in Chicago and a BA in Supply Chain Management from Michigan State University. My work has brought me to different parts... More
  • How Intraday Price Action Affected My Option Rolling Strategy 0 comments
    Jun 11, 2013 3:12 AM | about stocks: INTC

    Hi again everyone, the market is now closed and I wanted to look at how today's price action on Intel (NASDAQ:INTC) stock affected my options premium. It closed at $25.01, up $0.42. This is enough to skew delta out of our favor. ITM options have higher deltas the closer they are to expiration, which means the ones I'm holding are rising in price faster than the ones I'd like to roll out to. Let's look at three points of interest, the price to buy my call back (NYSE:A), the price at which I can sell Sept calls (B, C):

    A. The ask of my June $24 call closed at $84 on Friday, the ask at close today is $113, a $29 increase.
    B. The bid of the Sept $24 call closed at $145 on Friday, the bid at close today is $169, a $24 increase.
    C. The bid of the Sept $25 call closed at $95 on Friday, the bid at close today is $113, an $18 increase.

    As you can see, the delta component of the options pricing model skews premiums closer to expiration, and as we raise the strike price the delta is less. Let's look at the roll premium on each day:

    A. Friday: BTC @ -84.00 / Monday: BTC @ -113.00
    B. Friday: STO @ +145.00, credit 61.00 / Monday STO @ +169.00, credit 56.00, loss in credit -5.00
    C. Friday: STO @ +95.00, credit 11.00 / Monday STO @ +113.00, credit 0.00, loss in credit -11.00

    Something I think important to note, but not a major factor in these price changes as it's only been one day, is time value, or time decay. For readers that don't know, time value is the component of the option premium ascribed to the time left on the contract, and is larger as expiration gets further away, since there is more time for the price to gain. Time value on option premiums are measured by theta, which describes the rate of change [reduction] in the premium for each passing day, all else remaining the same. Theta is like delta in that it increases as we get closer to expiration, but it will decreases as the underlying gets deeper in-the-money. But in the case of the example above, it doesn't have much of an impact because the underlying price changed so much: this was delta skew, not theta skew. But just for fun let's look at the current theta of each option using an options calculator:

    A. June $24 call, theta -0.0113, or a loss of $1.13 each day due to time decay if nothing else changes.
    B. Sept $24 call, theta -0.0064, or a loss of $0.64 each day.
    C. Sept $25 call, theta -0.0066, or a loss of $0.66 each day.

    Time decay is less for the Sept $24 call because it is deeper in the money than the $25 call; traders are putting more time premium on the higher strike prices. This also illustrates how time decay can affect our rolling strategy if the price had stayed flat all day, essentially we'd pay $1.13 less to buy back the June, and collect $0.64 less for selling the Sept $24.

    Even though the time decay here is minimal, it will have an impact later in the week and closer to expiration, and this brings me to my big point: time value is in our favor. Every time we write an option, we take a bet that very little is going to happen between now and expiration, in the hopes that time decay simply eats away at the premium. And this is one of the biggest reasons option writing is becoming so popular with individual investors, we can generate income from basically sitting on our portfolios. That is an oversimplification, but we write contracts against our positions, that were already just sitting there, collect a bit of cash, sit on that for a week or two, and hopefully buy back the option cheaper, pocketing the difference. That's my perspective at least.

    And while that's not the whole thesis of this article, it does raise a good point about rolling options: why am I paying the market time premium to buy back an option that's not at risk of early exercise? Why not let the option exhaust all its theta before deciding to roll? It's getting close: INTC closes $25.01 with the June 24 closing at $1.13, the option sellers are asking a $0.12 time premium per share to write that, because it's only $1.01 in the money. While buyers of the Sept 24 calls are offering $1.69, or a $0.68 time premium per share.

    Go back to the theta numbers above, in the next nine days of trading the June 24 call will lose $0.1017 per share in time value all else being equal (9x -0.0113). The Sept 24 call will lose only $0.0576 per share in the same period (9 x -0.0064). So what's the point of even considering a roll today...

    The bottom line of this post is that I'm going to leave well enough alone until next Thursday/Friday when expiration becomes reality. There's no sense speculating on what the price may do by then, there's still a reasonable chance that it will close below $24 or at least get close enough to roll profitably. Being in-the-money is fine, ideally as long as the amount is less than the premium you collected writing the option in the first place. For example, if you sold the June 24 for $0.45, and INTC is trading at $24.30 near the close on expiration, then you can close the call for a gain, since the ask price will probably be the in-the-money amount, $0.30. If that happened, you wouldn't have to roll at all! Just close it out, take a small gain and walk away knowing you get to keep the stock.

    And there: I've introduced an additional consideration in the roll or not roll dilemma, the idea that in the last five minutes of trading your lucky stars will be shining and it will either expire worthless, or trade less than your sell price. Bravo.

    I'll be watching this one and updating how it goes.

    Disclosure: I am long INTC.

    Additional disclosure: The securities and situations described above, while real life, are not meant to be considered investment advice. The scenarios are presented to give an example of common option trading situations that can arise, and to offer a few ideas about ways to deal with them. I am not an investment adviser. I only share these in the hope that other young, non-professional traders like myself get exposure to what other like minded people are doing in the market.

    Stocks: INTC
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