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Why did apple mini calls lost so much although price went higher...?


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Why did apple mini calls lost so much although price went higher...?

  #1 (permalink)
 TraderTed 
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Hi,

I try to get a better understanding of option trading. I am using TOS analysis on options and I thought, that I had a quite good understanding of the subject. Obviously I was wrong about that.

So I bought 1 (as practice) May1 13 440 mini call. (I did this on earnings day, before the earnings.)

I expected the stock to go to $419 and the call should have been then at around $48 (the total risk was / is $34).

Now after earnings the stock is doing well as I have expected, but the price of the call went down to -$30 as of now. The options graph tells me that it will be at -$27 should it reach my expected target at 419.

So the stock did go up as expected without much time decay. The volatility of the stock also increased, which should make the call even more valuable. But the call still lost big time !!

Can somebody explain why is that ? What do I miss here ?

- Ted

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  #3 (permalink)
 
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 Fat Tails 
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@TraderTed: I am not trading options, but I will try to explain the basics.


The valuation of an option depends on the

- price of the underlying (delta & gamma)
- the implied volatity (vega)
- time decay (theta)

A call option has a positive delta and should the stock move upwards, the value of the option should rise. This is what you expected.

What you did not think about, was the implied volatility. Your May 1 calls were

- far out of the money
- and close to expiry

The implied (expected) volatility was high prior to the earnings release. This is what made the option valuable. After the earnings release the implied volatility dropped like a stone. There is nothing which will move Apple now, once the earnings release has been published.

Due to the drop in implied volatility the call option has lost most of its value. So let us resume:

(a) the increase in the price of the underlying had a positive impact on the value of the option
(b) the drop in implied volatility had a negative impact on the value of the option
(c) the time decay had a negative impact on the value of the option

The negative impact from (b) and (c) was much larger than the positive impact from (a), or otherwise put you were hurt because you were long Vega and had a negative Theta. The positive delta did not help you a lot. The rise in the stock price further contributed to reduce implied volatility, as implied volatiity is negatively correlated to the price of the underlying.


Or just try common sense:

The earnings release failed to push Apple shares close to 440 (the strike price) and they are now still hovering around 417. How do you think that they will now make it beyond 440 prior to next Wednesday?

The value of an option is the sum of all possible outcomes, each multiplied with the respective probability. As the probability that AAPL will make it to 440 is close to zero, the price of the option should now be close to zero as well. Prior to the earnings release there still was hope that unexpected good news would push the price upwards, but that hope is now definitely gone.


These were your mistakes:

- You did not take into account the fall in implied volatility after the earnings release.
- You bought an option too far out of the money.
- You bought an option close to expiry.


Recommended reading:

Lawrence McMillan - Options as a Strategic Investment
Sheldon Natenberg - Option Volatility & Pricing

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  #4 (permalink)
 
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 wldman 
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The DPM (same as the specialist for listed stocks) as well as traders in the crowd can adjust their implied volatility. They would do that in the same manner than a bookie adjusts the spread...he wants to attract wagers on the other side. Maybe the crowd is short vega? There are other reasons, like anticipated order flow they want it or they don't.

If you post more background, I could give you my opinion if you want. So, post earnings the May ATM calls decreased in price more than you think they should have based on the stock price?

Dan

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  #5 (permalink)
 
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 wldman 
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I'm not sure what a mini options is?

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  #6 (permalink)
 traderwerks   is a Vendor
 
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wldman View Post
I'm not sure what a mini options is?

10 shares instead of 100

Everything You Need to Know About Mini Options | [AUTOLINK]Breakout[/AUTOLINK] - Yahoo! Finance

Math. A gateway drug to reality.
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  #7 (permalink)
 traderwerks   is a Vendor
 
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This is the implied volume chart for AAPL

Math. A gateway drug to reality.
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  #8 (permalink)
 
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 wldman 
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a response to this and it disappeared. Some html code like language showed up. Any idea how to get my post back?

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  #9 (permalink)
 
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 wldman 
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did you say May 1st expiration? The theta (time decay) could take a huge hit on the price of a call. With 3 or 4 days till expiration? Didn't we have a "flash crash" last week? I do not follow aapl...so the crash and the earnings with this little time to expiration. Okay, if nobody in the crowd has a position, a big position...which they don't...nobody cares what kind of vol this thing is being priced at. When shit hit the fan...as it may have twice in the last few days the DMP backs out vol across the board with one click setting. When things return to normal they may not have dialed EVERY option back in with an across the board setting change. So if trades come in and they are off (the crowds displayed price) they will change their individual implied vol. settings. Someone from the crowd might say hey dial in those May 1 440 calls, but is more likely that the price moved out on a universal "oh shit" and it has not been dialed back in because nobody cares.

First question would be, "Where are the corresponding puts?"

Taking interest costs and execution expenses out of the equation you can check the prices by checking the reversal and conversion prices.

You are long a call so check the reversal first. A reversal is an arb strategy that you would do when options are under priced relative to the price of the stock. If you check the offer price of the stock versus the synthetic short stock described as long call and short put. So stock price minus strike price on the options plus the put premium (bid) minus the call premium (offer) should equal zero when the options are priced correctly. Of course the real life eq. will include trade costs and interest costs.

So, if there is a mis-price it is because nobody sees it and without an order in the crowd nobody is ever see or going to care about a one lot mini option. The guys in that crowd probably have thousands of front month regular contracts to worry about.

Plus the general interest in this product is not going to be sophisticated so they will try everything they can in the crowd...probably the new clerks reading Natenberg...to "steal" one.

So here is what you do if you are still long the call and the stock is up. See where you can sell a put. If the reversal is "out" don't ask for a market, hit their bid. If you get that done you are synthetic long stock. Offer ten shares of stock, presumably here at a level that would lock a profit.

Curious about how it goes.

Dan

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  #10 (permalink)
 TraderTed 
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@Fat Tails Thanks a lot for the explanation. My mistake was in mixing up actual volatility in the stock movement and "Implied Volatility" being very high before earnings, just because of earnings and dropping thereafter.


Quoting 
The earnings release failed to push Apple shares close to 440 (the strike price) and they are now still hovering around 417. How do you think that they will now make it beyond 440 prior to next Wednesday?

I did not take this into consideration, because I expected a quick rise to my target at 419 and wanted to get out there.

The time decay was not the big problem here. And I bought the call so far out of the money, to protect against another big drop of apple after earnings (as a kind of build in stop loss).

I was just not aware of the implied vol thing.


@wldman Unfortunately TOS does not let me sell puts or calls (no spreads at all), because I am from Germany. At the beginning of this year they changed their policy of giving margin privilege to foreign country account holders. So at the moment I can only buy puts or calls. Trying to utilize them as leveraged stock replacement for very short term swing trading.


Thanks a lot for all the answers!

- Ted

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Last Updated on April 27, 2013


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