Knocked Way OTM

Looking for insight on option chains. I bought Sept calls on APPL and CAT two weeks ago where the strikes were in $5 increments. Yesterday I looked after the open as both have been climbing over the last week, and now there are $1 increments up to my call strikes. I went from being 2 OTM to 12.

Is this normal after expiration Friday for the next month to expand like that? Thanks

Here's what S/O and I have come up with. We do not know why the strikes changes from $5 increments to $1 ones.

However if you are going to buy OTM buy out longer than 1 month. If you are going to buy only 1 month out buy ITM.

The only time S/O or I ever buy OTM is on Q's or if a stock is within a few cents of the next strike price and going in the direction needed to buy OTM.

I have looked all over for a better answer for you but I can't find one.

I will not pretend to be an expert on option pricing models but I am gaining an education now that I am starting to sell options. I cannot answer the question about why the strikes went from $5 to $1 or if that is typical. I will say that option pricing is based on the probability of the being ITM between now and expiration. Whether you are 2 strikes out or 12 strikes out is not as important as the fact that you are $12 (dollars) OTM either way. You still have the same number of days to expiration and I assume IV is relatively the same. Holding everything else constant the key is whether or not you think you will get enough of a move to make up spread, overcome theta decay, and still make a profit before expiration. I would not worry as much about how the strikes are listed.

On a side note I agree with Darcy. If buying this month then ITM is the way to go. ITM has less extrinsic value and thus less theta decay. You need time on your side if buying OTM. The peak of theta decay really accelerates from roughly 35 days to expiration for ATM options. It actually starts to accelerate around 55 days out but really picks up around that 30 to 40 day mark up until exp. If you are a couple strikes OTM then theta decay has a similar curve as ATM that flattens about a week before exp. It all depends on how much the stock moved during that time, how far you are still OTM, etc.

If selling an option then 35 to 55 days out is your friend. You are selling into theta acceleration. Assuming you are a technical analyst as many in this forum are then having the charts line up in your direction is an added bonus. I say that as I have been testing a pure statistical approach that does not believe in predicting market direction. You play the odds and adjust the trade accordingly when needed. I very much prefer when I have a directional bias as it requires much less work to manage the trade


NCT



Edited 1 time(s). Last edit at 08/22/2014 04:22PM by NCTrader.

Thanks Darcy and NC.

I bought these Sept calls in August before August expiration so I thought time was on my side with 42 days to the calls expiring. I think the percent change each day would be different if the strikes remained $5 apart as the underlying has risen $4 since I bought. Time decay is a factor but I'd have more of a profit by now if the 110 delta was not knocked way down.

Appreciate the insight from you as always, and the time you dedicate to this forum! Live and learn but pass it on.. That's why this is my only message board (are they still called that??)..

Agreed!

As I stated I will not pretend to be an expert. Just stating what appears to be general consensus among professional premium sellers while doing my research. The guys at TT seem to agree. The longest amount of time you want is 50 to 60 days if selling. Ideally 35 to 45 days is best. If buying the inverse is true. You need more time unless you have a momentum stock that is expected to move right now and only plan to be in the trade a day or two with max being a couple of days. If your general approach is similar to Darcy, Robert, and the short chart stuff Rookie was doing then this month or next month is fine but you might consider ITM to offset the rate of decay.

Below is a general representation of the decay curve. Obviously binary events and other factors impact the rate of decay. For former GW students it also supports the Barney vs. Rambo theory



NCT