Stock futures are surging higher this morning after the Fed announced yesterday that it is willing to accommodate the market and cut interest rates if need be (first cut expected in July).
In addition, market participants are optimistic heading into the G-20 summit, where President Trump and China’s President XI are set to meet and discuss trade on June 28 & 29.
I don’t really trade macroeconomic catalysts because it’s hard to find an information edge.
The type of catalysts that have led me to $800K+ in trading profits (year-to-date) have been stock specific…
Stuff like my FDA Insider Alerts where I find hidden gems like VBI Vaccines (VBIV)…
(Most people don’t even know where to look to find these trades. However, they are partly responsible for my $800K+ in trading profits this year. Want to start receiving my alerts? Click here for an 80% discount!)
As well as options… like this 50% winner I had in The Boeing Company last week.
(Options have taken my trading to the next level, but it’s something I eased into.)
However, with so many different option strikes and expiration periods… it’s easy to mess things up.
Getting the timing right seems to be one of the biggest issues new options traders face.
And unfortunately, if you mess this part up you can (more or less) kiss your chances of a profitable trade goodbye.
That said, I created this mini-tutorial on the role time decay plays in options pricing, as well as, tips on which strike price and expiry you should be targeting on your trades.
Table of Contents
Time Matters When You’re Trading Options
Time is money, and money is time.
When you’re trading options, understanding this concept is extremely important. You see, options are priced based on a mathematical model, and different factors affect an option’s price.
For example, options have an expiration date, and depending on which one you select… it could affect your probability of success.
Think about options like buying fresh fruit… there’s an expiration date… and if you don’t eat that fruit, you’re losing a bit of value every day as it approaches the expiration date.
Options work the same way.
Expiration Date and Time to Expiration Matter
The further the expiration date, the more expensive the options are.
Think about it like this, if you buy options on say Beyond Meat (BYND) expiring in three months as opposed to next week… the further-dated options have more time to allow the stock to fluctuate… when compared to the ones expiring in the next week.
Now, as the options expiring in one week approach the expiration date, those options will lose value faster. If those options are out of the money (the strike price is far away from where the stock is currently trading)… then chances are they’ll expire worthless.
Here’s a look at how an option’s premium is affected by time.
If you don’t know, an option’s value is comprised of intrinsic and extrinsic value. Now, with intrinsic value, it’s simply the difference of the stock price and the strike price.
For example, let’s say BYND $175 call options expiring next week are trading at $10 (let’s assume the stock is trading at $180). Well, the intrinsic value here is $5 ($180 – $175). On the other hand, the extrinsic value is $5.
Now, the extrinsic value is sometimes referred to as time value… but there are other factors affecting this, such as implied volatility.
That said, when you’re buying options… there’s one question you need to ask yourself, “Am I buying enough time?”
For example, when you buy deep out of the money (OTM) options expiring in a week… chances are you’re going to lose all of your premium.
You see, you have to also ask yourself, “Does it make sense”?
In other words, does the strike price and expiration date you’re looking to buy make sense?
A Look At How to Select Expiration Dates and Strike Prices
Check out the hourly chart in Boeing Co. (BA).
Now, back on June 11, there was news surrounding Boeing’s 737 Max orders… and there have already been fears of problems with the plane.
The big fear was that there would be more cancellations if the company doesn’t resolve the issues… consequently, that would hurt the company’s revenues and earnings.
I figured the stock was going down, and I was looking for the right strike price to buy.
Well, Boeing was trading just above $350 when this news hit… and I was looking for the stock to move to the downside after that negative catalyst hit the wire.
My thinking was BA could break below $350 pretty quick, so I decided to buy those options expiring on June 21 (about 10 days until the expiration date at the time).
Could I have bought myself more time?
However, I would’ve been paying a hefty premium… and time that I didn’t think I’d need.
Here’s what I sent out to clients.
Now, the very next day… BA got some selling pressure and broke below $350.
Those slightly OTM options became in the money… and the option’s value spiked by 50%!
A lot of the times, traders will look to buy OTM options… thinking they’re cheap and the stock will get to that price level. For example, it wouldn’t make sense to buy $300 strike price options in BA expiring in three days… because chances are it’ll need more than a week to drop around 15%.
Now, it does take a little bit of creativity when selecting options expiration dates and strike price. For the most part, I don’t go too far out of the money when I’m trading options… and buy myself enough time for the move to materialize.[Ed.note: Kyle Dennis runs BiotechBreakouts.com. He is an event-based trader, who prefers low-priced and small-cap biotech stocks.
Source: BiotechBreakouts.com | Original Link