Why didn't I make money on my option?

Question

I purchased two calls (NSIAM) on Nutrisystem (NTRI) in Nov. with a Jan strike price of $65. The price of the options was 5.70 per share. The stock price was ~$67. NTRI is now at 67.82 and NSIAM is at 3.30 per share. This is a $480 loss for me plus fees. What I don't understand is why I lost $ when NSIAM is above the strike price and NTRI is above what it was when I bought it. Can someone explain this to me? THANKS!

Answer 1

O dear. So sorry to hear this. It's a classic situation.

Your jan 65 calls will expire 1 week from today, and they have entered the final period of their life during which the time value portion of the option price decays most rapidly.

Using the figures you mentioned, the intrinsic value of these calls is 2.82. If every other variable were to remain constant between now and next friday, the intrinsic value would be all that would be left, although the B/A in this hypothetical case would probably be something like 2.75-2.90.

Do you see how the rapid approach of the expiration date is causing this effect? Imagine a graph of your calls since you bought them in november. Their price fluctuates with the stock on a very short-term tracking basis, but the general trend has been down. This downtrend has recently accelerated.

From now on, your stock will need to be trading close to 70.70 for you to make any money. Today we'd be south of 70.70, but as the days of next week pass this breakeven price will creep north.

You could easily find a situation on any given day next week when a modest rise in share price will be not only cancelled but negated by decline in call option price due to one more day of time value decay in final week.

There are several things you could do, and I'll put the most desirable action last.

1) consider if NTRI might, indeed, jump up past 70.70 next week. Any major news expected? any earnings announcements coming up?

2) (a) sell the position and take the loss;

2) (b) sell the position, take the loss, and resolve to learn as much as you can from it (most desirable action).

Have you studied as much as you could? Early in your readings you'll encounter explanations of time value decay. Excellent tutorials at the Option Clearing Corporation website will explain this concept, with charts and graphs to make it palpable.

http://www.888options.com

There is a very good small book you can download and study for free at the Montreal Exchange website. Click publications, click Equity options strategy manual. This takes the reader from introductory basics to advanced concepts like the "greeks," which are lognormal progressions that are, in fact, controlling the time decay that's happening right now.

http://www.m-x.ca

Borrow books on options trading from your local library. The universally respected text is Lawrence Macmillan, Options as a Strategic Investment.

In short, study, study, study.

In closing, a caution: countless studies have shown that it's the buyers of calls and puts who lose money. It's the sellers of these options, often in double, triple and quadruple spread combinations, who stand to make money, because they are repeatedly selling the very time value that you are, alas, losing these days.

Can you see - to oversimplify this example - how well your option seller has done since november when he sold the jan 65 call to you for 5.70? today he could buy back his call and close out for something like 3.30-3.40. Yet the stock itself has merely inched up by $.82. He was selling time value.

In time, you will too. Good luck in all trades

Answer 2

Remember that the underlying asset price and the option premium are related, but distinct: an increase in the asset price does not necessarily result in a corresponding increase in option price, and volatility is the key. First determine what your break-even point is: the strike price plus the premium paid. NTRI must exceed 70.70 (65.00 + 5.70) in order for you to make any money on your option. It's apparent that volatility has dropped, since the price of the option has decreased from 5.70 to 3.30. In other words, the market confidence that the asset price will meet or exceed 70.70 is far less than its confidence that it will meet or exceed 68.80. Hence, the NSIAM 65.00 call is worth less than 5.70.

So although the price of the asset did indeed rise, it didn't rise enough to support an option premium of 5.70. The new option price of 3.30 represents the premium you can sell the NSIAM 65.00 call to offset your long position, resulting in a 2.40 loss per position. You have 2 positions, resulting in a 4.80 loss, or $480.

Answer 3

The answer is very visible. On NTRI to make money before any transaction costs the price should be 70.5 which is not the case. It is only 67 meaning you lost $300 there. Something similar might have happened in NSIAM where you lost another $180.
When buying out of the money options this happens. You bought it deep out of the money where the price has to double to the price of the option bought for anyone to start making money. Naked options are riskier.