Why doesn't everybody buy the 5 cent stock options just prior to expiration?

Question

It seems to me that if I buy options 2-3 days before expiration that are only 50 cents out of the money, all the stock itself needs to do is add $1.00 in 2 days for me to have a sweet payday. Today MSFT is $29.55, Feb $30 calls are 8 cents each. I can buy 400 for $32.00! Seems to me like the stock doesn't need to move much in a couple days. What am I missing?

Answer 1

Although there is a lot of truth in the answers you have received so far, there is also a fair amount of dubious/wrong information. Let me give you my thoughts on the previous answers.

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Charles C is quite correct that you could only buy 4 contracts for $32. To buy 400 contracts at $0.08 would cost you $3,200.

I think the comment about the stock volatility is a little misleading. It is the amount of volatility expected before expiration (called implied volatility) that is important in option pricing.

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Tom P's comment that "Retail commissions will be about $350-$400 + your $32" is based on 400 contracts instead of 4 contracts. It is also based on some common published commission schedules, which may or may not apply to you. Some brokers have asset-based fee accounts and charge no commissions for online transactions.

He is absolutely correct in saying "You lose all of your investment if the stock does not go up."

He is correct that you need to sell the contracts before expiration or exercise them to realize a profit. However it the stock is in the money close to expiration you can sell it short and then exercise ithe options to cover the short, so you would only need enough margin to cover the short stock position. That margin can be supplied by other holdings in your account instead of cash.

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I agree with Allen that buying cheap out of the money options is a lot like buying a lottery ticket.

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muncie birder's remark that "those who sold you the options will do their dead level best to make sure the stock does not advance to in the money" is, IMHO, way off base. Market makers will hedge their positions which, depending if they are long or short, may help or hurt the chances of the stock passing the strike price. Given the number of option contracts outstanding for MSFT four or even 400 contracts is not going to have a significant impact on the stock price.

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I don't know where Yada Yada Yada came up with "8% (+ commissions) that it's costing you" since eight cents is clearly not 8% or $32.00.

I agree with the rest of the post, but I think it is worth noting that the spread mentioned is very different in terms of a risk profile. That spread has a maximum profit of $50 and a maximum loss of $950 so, while it is more likely to be profitable, the amount at risk is much greater than the $8 you would be risking per contract, while the maximum profit possible is much less.

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Now a few of my own thoughts.

One thing you need to realize is that MSFT is one of only a few stocks that uses penny increments in opion pricing as a pilot program that started less than a month ago. For all other stocks the option quotes must be in increments of five cents. So, if you buy an option for five cents a day or two before expiration, it is likely that the stock will have to go at least ten cents beyond the strike price before you can sell it for a profit.

It is also worth noting in your question you specified "2-3 days before expiration" but your example used an option one day before it stops trading. (Technically it does not expire until Saturday, but since you cannot trade it after Friday's close that does not really matter.) Time decay for options prices is most severe close to expiration, so if the stock had closed a $29.55 on Tuesday or Wednesday it is very unlikely you could have bought the option for eight cents.

Finally, if you try to wait until the last couple of minutes before the 4:00 closing on Friday to decide how to exit your position, those trading on the floor of the exchange have a real advantage over those trading through the internet. One glitch in the network, and you may not be able to get your order in.

Taking cheap expiration week long option positions is a recognized trading strategy, but it is usually done when earnings or some other event is scheduled before expiration, and the position taken is usually a straddle (long both a call and a put).

I's sorry if I was a little long-winded. Brevity is not my forte.

Answer 2

You're missing the probability of MSFT moving that much in that time period is much less than the 8% (+ commissions) that it's costing you.

If you look over time, MSFT doesn't move very much to begin with. Not only are you looking for a directional move for it in one day (not bloody likely), but you're looking for it when there's no impending news announcement and on a stock that barely moves. Hence, why the options are so cheap.

Now if you wanted some really easy money, you would have done a 1835/1845 bear call spread on the NDX today near close and gotten between 0.30 and 0.70 for 9.50ish risk. That's roughly a 5% return in a couple of hours barring huge movements overnight before settlement price in the AM. BTW, it closed near 1821, so it would have to move a LOT overnight to be close to losing any money there (B/E is 1835ish).

That's a much higher probability trade.

Hope that helps!

Answer 3

You can actually buy 4 options for $32. This will give you the right to buy the 400 shares. However, options are priced based on stock volatility and a few other variables. Stock volatility is the biggy though. Without volaitle movement there is not much value in an option.

Answer 4

Item 1: Retail commissions will be about $350-$400 + your $32.

Item 2: You lose all of your investment if the stock does not go up.

Item 3: If MSFT closes above $30 on Friday you have to come up with 400 x $30 = $12,000 to exercise your calls, or you must sell the calls before market close and incur another commission.

Answer 5

10-15 years ago, 5 cent = "asam jawa" candies. 50 cent = i'm the rich bastard in my school with higher chances of getting laids. Nowadays, 5 cent = when i'm trying to buy something, people look at me like i was a caveman that travel through time with time machine. 50 cent = i can get one Otak-otak at Jalan 223, PJ.

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Answer 6

Because the chances of that happening are quite low. You might as well buy a lottery ticket, where you know what the odds of winning are.

Of course, if you have a deep understanding of the company than that is a different matter.

Answer 7

1

Answer 8

You forget that those who sold you the options will do their dead level best to make sure the stock does not advance to in the money.

Answer 9

Yes, it's possible

Answer 10

Great replies, just what I was looking for.