Getting started with options trading page 4



One of the reasons that I tend to stay away from earnings plays with options is so many things have to come together.  There are countless stories of a company reporting blowout numbers, but then temper guidance expectations for the next quarter or year and then the stock doesn't move as high.  As previously mentioned, sometimes with the most favorable numbers, the street might sell off the stock and the option goes down with it. With call options, this means the value of the options goes down. Since the earnings are known, the volatility quickly comes out of the option after earnings and this is another factor working against you.

I read too many times on message boards of people complaining that the game is rigged since the stock appreciated, but the option price hasn't budged or even gone down after earnings.  They fail to realize that the implied volatility comes out quickly which is a factor in pricing of options.

Especially after earnings, the volatility comes out of the option so quickly that there are variances in the true price of an option.  I've seen many instances where no options were hitting the tape because the bid was below the price that one could get if you exercised the option and immediately sold the underlying stock. Problem doing this is you have to come up with the thousands or hundreds of thousands to come up with the money to exercise. Let's say you are holding 20 call options for a $100.00 stock that you bought for 30 and right now you can get 60, but you figure you can do a little better by exercising and selling the underlying. Those 20 call options would require that you put up $200,000.00 or you could buy on margin (another fee) even though you are selling on the same day, but your money is tied up for 3 business days with that transaction.

Consider yourself lucky that stocks settle in 3 days.  Not too long ago, back in the day (early 90s) settlement on stocks was 5 days. .  

This brings us to how is the price of an option calculated. There are six factore that influence the price of an option: option strike price, market price of the underlying stock, dividend yield if any, prime interest rate, proximity to expiration date, and the volatility of the stock prices over the course of the option. There are times where the volatility is the biggest influence on the price of an option. continued



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