Doc Maher reviews Pman1972's trades
In the Long Call play, especially within days of expiration week, your option is losing value as fast as an ice cube melts on a hot summer day. In order to make money here, you need the stock to take off like a shot, similar to those bottle rockets you lit on July 4th. Good luck trying to return any unused fireworks after the holiday. It may be best to hold on to them..."wait and see" for next year. (Rookie's Corner is below.)
Pman1972,
After I read your trade notes, I was reminded of infomercials reciting the slogan, "satisfaction or your money back guaranteed." It seems that you didn't fully understand the risks when taking on this position, and therefore the trade did not turn out as you thought it should. From what you posted I'm not sure what exactly you expected, however your comments that you bought short term "In the Money" (ITM) and "there should be a small profit when this options expires..." seem to indicate that because the option was ITM that you expected it to make a profit at expiration.
This is of course not true as you found out. So here is a review of some basic option concepts to illustrate what went wrong. When you buy or go long an option there are only 2 ways that option will increase in value. The first way is for the underlying, in this case SIRI, to move in the expected direction (up). The second is for the Implied Volatility to increase. (To learn more about volatility, click here.)
However there are 3 things that will tend to make the option lose value. In this case if SIRI moves in the opposite direction, the Implied Volatility decreases, or time passes. Ultimately whether or not the strategy is profitable depends on all three of these factors.
So first does buying ITM options increase your chances of profiting? Well not really. If SIRI had stayed at the same price as when you bought your call option it would still have lost money due to the time decay. (For more on time decay, click here.) When you own an option, time is always working against you. As I mentioned, the only way that the value of the call can increase is for SIRI's price to increase and/or the Implied Volatility to increase. The key is that one or both of these must be enough to offset time decay.
Since I can't go back in time to show how this worked for SIRI, to illustrate this I will use another stock and start my analysis on 4/11/2008. Below is a profit and loss plot for IBM using a May 115 Call. IBM closed at $116 on 4/11/2008 so this is an "In the Money" call. The plot shows the expected profit or loss for 4/11/08, the day the trade was analyzed. (This application may be found under Tools > Profit+Loss Calculator.)
Click here for a larger image.
As one can see if the stock moves up the value of the Call is expected to go up and if it drops the opposite. However this plot is only good for the date shown, 4/11, and the current Implied Volatility.
Let's look at what happens as time passes. Below is the same plot except the date has been advanced to May expiration, 5/17.
Click here for a larger image.
The plot above shows that even though IBM is still at $116 that the May $115 Call would have lost $380 at expiration due to the time decay. IBM would have had to move up to $119.80 just to break even. So ITM Calls will lose value with time if the underlying does not move up. Of course in the case of SIRI the stock dropped so you had both time and stock movement working against you.
The above assumes that the Implied Volatility stays the same. In the case of SIRI this didn't happen either. Below is the Implied Volatility chart for SIRI. We can see that in the time between late March and early April that the SIRI options were losing Implied Volatility.
Click here for a larger image.
From this chart it is possible that SIRI options lost as much as 10 points of IV. Below is a plot of IBM to illustrate the impact of dropping IV. This image is the P&L for the day of entry 4/11 but with a 10 point drop in Implied Volatility.
Click here for a larger image.
In the above image, the price of IBM hasn't changed and no time has passed, but 10 points of IV have been lost. The P&L shows a loss of $152.
So in the case of the SIRI April $3 Call we had all three things go against this trade. The Underlying dropped, the IV dropped and time passed.
In the end, I am not quite sure why you closed this trade for $.05. At that point you only saved $5 for the one contract and with the commission, basically nothing. The call had already lost everything it could; the value can't go negative. There was nothing left to lose and who knows maybe something good could have happened before expiration. But that's for another discussion.
Thanks for sharing your thoughts with us. Although everything seemed to go against you in this trade, you are not alone in having this experience. The main point is not to dwell on the course of events, but to identify what happened, and to bring that knowledge and experience to the trading page next time you enter the market.
"Income Trader"
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This comment and any market data included here were prepared on 4/11/08.
ROOKIE'S CORNER
The Play: Long Call - Play #1
This post best suited for: All levels
Outlook: Bullish
Who should run this play: Veterans and higher
Trader: Pman1972
Trade Status: Closed; entry and exit data
Trade Recap:
SIRI = 2.48 as of 4/11/08 close
3/25 9:51 am Trade 1: Bought to open 1 SIRI Apr 3 calls @ 0.35 SIRI = 3.09 as of 3/25 close
4/7 10:15 am Trade 2: Sold to close 1 SIRI Apr 3 calls @ 0.05 SIRI = 2.74 as of 4.7 close
Current market 0.00 - 0.10 as of 4/11 close
Trade Result: -86% loss on investment; $0.30 loss per contract
Trade Duration: 14 days
Trade Notes: "I bought 'into the money' for a very short period of time. The option expires this month. There should be a small profit when this option expires. Not to mention, the DOJ approved the merge, I figure it wouldn't hurt to have a little skin in the game if the FCC ever gets around to approving also. We'll see." - Pman1972 long call entry
"Totally disappointed. I bought this option 'in the money' and walked away happy. Not even 3 weeks later, I see that Sirius' debt has climbed well into the $Billion threshold and the stock price (and the option) tanked down in the last week. And to top it all off, the stock was downgraded to 'neutral' by Credit Suisse. Had to close in order to keep the shirt on my back! Luckily it was only 1 contract." - Pman1972 long call exit
Next Earnings Announcement: 5/27/08 unconfirmed
Long Call - Play #1 (Education > The Options Playbook > The Plays > Play #1)
A long call gives you the right to buy the underlying shares at Strike Price A (3). Calls may be used as an alternative to buying the stock. You can profit if the shares rise, while limiting the risk that could result from purchasing the stock. It is also possible to gain leverage over a greater number of shares because calls are usually considerably less expensive than the stock itself. But be careful, especially with short-term out-of-the-money calls. If you buy too many option contracts, you are actually increasing your risk. Options may expire worthless and you can lose your entire investment, whereas if you own the stock it will usually still be worth something.
Break-even at Expiration:
Strike A plus the cost of the call. (3.00 + 0.35 = 3.35)
The Sweet Spot:
The stock goes through the roof.
Maximum Potential Profit:
There's a theoretically unlimited profit potential, if the stock goes to infinity.
Maximum Potential Loss:
Risk is limited to the premium paid for the call option.
Margin Requirement:
After the trade is paid for, no additional margin is required.
As Time Goes By:
For this play, time decay is the enemy. It will negatively affect the value of the option you bought.
Implied Volatility:
After the play is established, increasing implied volatility is your friend. It will increase the value of the option you bought. It also reflects an increased possibility of a price swing (without regard for direction).
Options involve risk and are not suitable for all investors.
Please read Characteristics and Risks of Standardized Options.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.
The Greeks (Delta, Gamma, Theta, Vega, and Rho) represent the consensus of the marketplace as to the how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that these forecasts will be correct.
While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.
Jonathan F. Maher, PhD. has a professional business relationship with TradeKing.
He does not hold a position in SIRI or IBM.
