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When do you Make a Profit.....
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When do you Make a Profit.....

  #1 (permalink)
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When do you Make a Profit.....

when trading just a regular Call option.

Example..... MCD currently trading at $93.55
The September $94 Call ( 28 days to exp. ) has a Bid of .90 and Ask of .98
So my question is, when exactly will I start to make a profit on my Call option?
Does the Option/Stock have to move.....
1. The .08 cents between the Bid x Ask spread
2. The cost to buy the Call for .98 cents
3. The difference between the $94 Call minus the price that the stock is currently trading at of $93.55 = .45 cents

So is the total required move in the stock, before I realize 1 cent of profit , $1.51 ( .08 + .98 + .45 ) ?

Thanks for the help, very much appreciated - Michael

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  #2 (permalink)
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  #3 (permalink)
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Omer עומר / Israel י
 
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Option pricing



mdsvtr View Post
when trading just a regular Call option.

Example..... MCD currently trading at $93.55
The September $94 Call ( 28 days to exp. ) has a Bid of .90 and Ask of .98
So my question is, when exactly will I start to make a profit on my Call option?
Does the Option/Stock have to move.....
1. The .08 cents between the Bid x Ask spread
2. The cost to buy the Call for .98 cents
3. The difference between the $94 Call minus the price that the stock is currently trading at of $93.55 = .45 cents

So is the total required move in the stock, before I realize 1 cent of profit , $1.51 ( .08 + .98 + .45 ) ?

Thanks for the help, very much appreciated - Michael

There are two elements that make the price of an option.
a) the value that you are 'in the money', means current price of the underlying instrument - minus the strike price for a call, and oposite for a put, difference between the strike price and the current price.
in your example, the option is 'out' of the money, means current trading price = below the strike price, that part =0, for a call and vice versa for a put.
b) the expectation/time value, that is a combination of the volatility of the underlying instrument and the time until the expiration data of the option, in your case the September.

In order to make money, you would have to sell the option, at the price you bought it + the transaction costs (depends on your broker).

You can buy immediately at the ask .98, if the same moment you want to sell, you only get .90 you can always put an order with a limit, and wait if someone is ready to enter into a transaction at the price of your limit.

Between today and the expiry date, the 'expectation'value will slowly go down,
the premium people are wiling to pay for the option will reduce as time gets shorter.

you can make a profit on two ways

to make profit at the expiration, the stock would have to be more than 95

however
if the stock starts to quickly move in the next few days, let's say goes to 93.99, the option would be trading higher than the current price and you would be able to sell it for a profit before expiration.

a famous formula to calculate the pricing of an option is the Black and Sholes model.
Black?Scholes model - Wikipedia, the free encyclopedia

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  #4 (permalink)
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Thanks for the reply rleplae.

So was I correct on the stock having to move $1.51 before I start to make a profit, as you stated, it would have to be just above $95 ( the current price it's trading at of $93.55 + the $1.51 ) ?

Thanks much, I appreciate it

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  #5 (permalink)
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mdsvtr View Post
Thanks for the reply rleplae.

So was I correct on the stock having to move $1.51 before I start to make a profit, as you stated, it would have to be just above $95 ( the current price it's trading at of $93.55 + the $1.51 ) ?

Thanks much, I appreciate it

No, you are not correct.
the answer is , it depends

The price the stock needs to achieve in order to make a profit depends on the timing
If the price on Monday goes to 94, your option would probably already make a profit
If the price goes to 94 one day before expiry, the option would probably be 0.1$ and you would loose a lot
On the last day, it is fair to say that the price would need to move 1.51$ as you mention.

With options, the timing is important, of course in the money is in the money.
But as the option of your example is out of the money, it means that you are paying only expectation (time) value.
Tomorrow that expectation value will drop a bit, but not to zero.
Hence the dependency on timing for the correct answer.

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  #6 (permalink)
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Can't you model that on your TOS platform? I highly recommend you investigate that functionality. It's a must for pre-trade analysis.

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  #7 (permalink)
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short answer...

you'll be lucky to get the mark price.

you're going to have to analyze the greeks in order to determine the future value, if any, and what the probabilities are of that occurring. there are 4 greeks, and depending on where price, time and volatility are in the expiration cycle they (delta, gamma, theta, vega (rho, I guess 5, but rho is negligible)) will determine if you're going to make a profit or not. here's a very, almost super basic rule to follow - buy .50-.70 delta with around 30-50 days to expiration, sell it back at any time if it reaches .85-.90 delta (.90 being on the late side) - yes, you can and should buy another, or even more if you think the price is going to continue to rise. I wouldn't recommend holding onto it under 20 days to expiration or you'll lose the remaining value quicker (theta).

anyway, thinkorswim has a built-in options theoretical calculator but it takes quite a bit of work to get your head wrapped around it.

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