OTM options trade, and the profit per .01 cent move....
Need some help in understanding the amount gained based on trading OTM options......
From my understanding, this is how an OTM option works....... say MSFT is trading at $24.07 and we buy the 1 month out $25 Call for .57 cents , So.... for us to realize a profit, the underlying stock of MSFT , would have to move a $1.50 ( from $24.07 to $25 = .93 cents + the cost for the $25 call,which is .57 cents = a $1.50 move is needed in the Underlying stock of MSFT, before we'd begin making a profit. Which means, that MSFT would have to get above $25.57 ) ...... this would be a 6% move in the underlying stock ( that is quite a big move in the Stock, unlikely ? )
In the Example above......Ho do we know how to figure out, how much money we'd earn on the ATM or OTM option, once the price in the Stock, exceeds the price of $25.57 . Say it got to $25.58 , $25.59 , $25.60 , etc.... How much would we make as a Profit, per penny / per .10 cents/ per $1 that MSFT goes above $25.57 ? ( Hope my question isn't to confusing ) lol
Thank you for the help, much appreciated - Michael
Your assuming you have to hold the option to expiry. If MSFT rallies 50c today, the option will probably rally 15c-20c today as well. Hence if you then sell the option you have an approx 30% profit before commissions. Theres a big difference between the value of an option at time t+1 and at expiry. I would suggest you look into "option greeks".
- Delta is the amount you would expect an option price would change due to a change in the underlying
- Vega is the amount you would expect an option price would change due to a change in Volatility
- Theta is the amount you would expect an option price would change due to a period of time passing (ie a year/250 = a day)
Again this goes back to the option greeks. Theres lots of software out there (or not difficult to create it yourself in excel) where you can see a 3D surface/chart which shows option value based upon underlying price and time to expiry or other combinations of metrics. Price can easily be substituted for Profit & Loss, ROI or something similar.
For example from a quick Google Images Search
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The delta is the greek that relates to your question the most. You can use it to make a rough guess on how much profit you stand to make or lose per $1.00
For example using the February $36 Calls for MSFT in real life, the current B x A is $0.94 x 0.95, and the delta is 0.44. That means for every dollar that price moves, you gain 0.44. So if MSFT went from $35.53 -> $35.63, your calls would be worth approximately $0.94 + 0.44 = $1.38
That answers the basic portion of your question, but as SMCJB illustrated, delta is just one part of many that make up the price of the option. Gamma and Theta are the two other greeks that I think would be ideal for you to research next