I recently got burnt on a call that did not exercise because there was not enough time. How much time should

Question

I allow in today's market for a stock price to move adequately in the profitable direction in an option so that the time decay does not spoil the profits?

Answer 1

As much time as possible...

Generally it's cheaper to buy additional time for an option. For example a JNJ Jan '09 70 call costs $4.40/share, while a Jan '10 70 costs $6.80-- you get a whole extra year for only $2.40. Also with long term options time decay is a relatively minor factor--if JNJ goes up 20% an option that doesn't expire for at least a year will make you a lot of money.

Time decay will really eat away rapidly within a month of expiration, especially with well out of the money calls. I prefer to buy options that don't expire for at least a year, and am very leery about buying any options that expire is less than six months (generally when I do I've gotten burned). Oh and for the record I have made money off of options.

Answer 2

Pretty hard question to answer in trying to just frame it in the way that you ask it. It isn't just about "how much time to allow". All options contracts have a time frame that's specified when you purchase the contract. They all also have to fundamental parts: time value and inherent value. At expiration date, you are left with no time value and it's all inherent value, if any. If the contract is "in the money", that is, a call with the underlying stock price higher that the strike price, then the value of that contract is going to be the amount that the stock price exceeds the strike price, (this is at expiration date), as it has no time value left.
In general, there are a few ways to "get around", for lack of a better term, the time value decaying away your option contract value. One of which is to buy options contracts on stocks that have a high price volatility. If the price of the stock fluctuates a lot, so too will the price of the contract, although it's most likely not going to be dollar-for-dollar. Another way is to buy contracts for stocks with upcoming earnings announcements, although you need to realize the particular risk of this. The idea is that due to the "unknown" factor (that is, what ARE the earnings going to be, good or bad), there is extra premium built into the contract. This is a real risk/reward thing here. If the price of the stock shoots up due to good or better than expected earnings report, then the cost of the contract is going to go up as well, and if you're the owner of a call, then that's what your looking for. Just a little food for thought.
My question is, do you want these calls to exercise? You said it didnt' exercise, but I'm thinking that's not what you meant? By most accounts, people don't actually want the contracts to exercise, if you bought a call, most want to have the cost of the contract to go up, so they can sell the call to close out the position. (the same concept as buying low and selling high, you want to buy the call at a lower premium and sell it at a higher premium). Hope this helps.

FYI, if you're just getting the "hang" of buying calls, you may not be ready for spreads yet, so what a previous person answered, while may be correct and valid points be made, if you're not trading options at that level yet, just keep what you're doing and learn the more basic trading and strategies first. And your question does have a purpose and value to it. It's a common question. You can't learn if you don't ask questions.

Answer 3

once you only buy options you are already stacking the deck againt you. Time decay favors the sellers and the option market was created to favor the person who will go in and buy the underlying security and sell the option. Its not about how much time..its about buying a wasting asset. A better strategy is to always to incorporate spreads into your strategy..by buying a deeper in the money call and spreading it off on an option that will effectively wipe out all or most of the time value in your trade . Often you can get a discount over what the actual stock is trading at. This way the time frame isnt as important. If you eventually excercise your winning long call position you can either stay short the other call option or buy it back and sell another one out in a further month at the same strike or higher..depending of course on many other factors involving your invesment strategy...looking for rules of thumb like this question poses serve no useful purpose..

Answer 4

I agree with what baronmoonmeister said.

I will add a couple more points.

If you are trying to trade options based simply on your belief that a stock is going to go up or that it is going to go down, you have a tough future in front of you. The best way to benefit from an anticipated increase in a stock's price is simply to buy the stock. The best way to benefit from an anticipated decrease in a stock's price is to simply short the stock. Only trade the options on a stock when you have a reason to believe the implied volatility of the option is higher or lower than the actual volatility the stock will experience before expiration.

Also, because theta (time decay) increases nearly exponentially as expiration approaches, I rarely like to hold a long option position all the way until expiration. While it is true gamma can work wonders for options near expiration, it is more common to see what "time value" you had eroded away.

Answer 5

Buying options further out sounds great as it gives you more time decay but few people understand and take into account what a volatility crush will do to that option price. It can kill you just as badly as not buying enough time.

If I'm cough in a losing option that doesn't look as though it's going my way, I'll simply sell the option back. It's better to retrieve some of that 'risk' capital than loose all of it in a bad trade.

Answer 6

If you are refering to a call for stocks, ill assume it to be a warrant.

If you are dealing with stock warrants, i think it is important to realise that stocks (in singapore particularly) has lower liquidity compared to other investment tools like forex. To make things worse, while forex has 4 major pairs to deal with , there are thousands of counters in just one market and the counter that you have bought might not have enough liquidity to provide enough price movements for you to make full use of the leverage effect of warrants.

As an average investor, you can try an (ABOUT 5%) out of the money warrant with around 3 months and ABOVE to muturity warrant.

I would however, advice you to look at index warrants, like those of HSI warrants. The index provides enough movement for sufficient price movement in the warrants. In addition, the nature of an index diversifies industry related risks that you might absorb from buying a particular share warrant.

Hope this is of some help

Answer 7

This is what I was taught AND LEARNED about options:

Look at the past trades I was in. Figure an average. THEN add 30 - 60 more days. This applies to Calls and Puts.

Thanks for asking your Q! I enjoyed answering it! VTY,
Ron Berue
Yes, that is my real last name!

Answer 8

You need to find some simpler investments. Based on your posts, you are playing around in all kind of risky investment schemes.

There is no free lunch. If it sounds too good to be true... Etc.