Below are two of the most common questions we didn't get to last week:
If I understand correctly, Teeka is saying that the OSX June 160 is going from about $31 per contract the day after thanksgiving to $420 per contract at expiry. Is that correct???
Put another way, if the index is at 181.73 now, it would reach 181 420=$601 at expiry. This really does seem highly implausible. And if he really thinks that, why not just buy 1 contract of the 210's at $6 or $600, way less risk than the deep in the money 160's, and if the 210's go to 601 as he appears to predict, he would still have a gain per contract of $391 (601-210) for a truly spectacular trade.
Please confirm these numbers as correct or is my option math way off.
“Dylan, First of all nothing is guaranteed. Statistically speaking stocks spend 68% of the time trading within plus one or minus one of the standard deviation of the mean. That means that stocks spend 68% of the time just "middlin". Buying deep in the money calls is a risk control strategy that does two things. It gives us a better "DELTA" and protects us if the index trades flat. The Delta is the amount the option moves in relation to the underlying stock or in this case to the underlying index.
A Delta of one means the option price will move one for one with the underlying stock or index. To get a one for one Delta you have to buy deep in the money options. When buying options on stocks I routinely buy options at least five points in the money in order to achieve a one for one Delta. When you buy "at the money" options i.e. stocks trading at $50 and you buy the $50 calls your delta drops to .50 to one. So for every dollar the stock moves up in value your option will move up by half a point. The option will not achieve a Delta of one until the option moves to at least five points in the money.
Now let’s tackle your example. Your absolutely right, on the surface of things buying the OSX 210 options for $6 (last quote had them offered at $6.70) appears to make the most sense in the world.
Now I run money for a living and more than liking to make money I absolutely hate to lose it. So I have to ask myself what if I'm wrong on this trade, what if my logic is off or my timing isn't right, what happens then? You see as a money manager I cannot treat the stock market like a Monte Carlo Casino and say bet it all on black. I'd be out of business if I did. I have to make educated investments based on my market experience to put my team in a position to win but more importantly I have to make sure I don’t sink the ship if I'm wrong. It's called risk management and far too few individual investors practice it.
Here's the problem with buying the June $210 calls: if I'm wrong and the index trades flat or down I lose everything. Even if the index rallies 15% to $210 I'd be lucky to break even and would probably lose money. By buying the June 160 calls I give up some leverage but I buy a whole lot of piece of mind. I f the index trades flat I'll probably lose between $300 - $400 an option, if the index rallies 15% I'll make $2,800 an option for an 88% return over 6 months vs. a loss or break even on the June 210 Call options..
Now here's the shocker I don't know how long it will take for the OSX index to hit the 600's. I do not have a crystal ball but I've been in the market long enough to know that the market is capable of "implausible" manias. If the OSX traded LEAPS I'd buy them but they don't. What I intend to do is "roll" my options into the next furthest series once we get into April and assuming that my investment view remains the same.
Let me please reiterate that this trade is for high net worth sophisticated traders only and involves substantial risk.
What is the exact contract Teeka was buying himself?
"Before I tell you that let me once again say that for the vast majority of investors this is an inappropriate, high risk trade and you should be prepared to lose your entire investment if this does not work out.
This is a “no tears” trade for big boys and girls that can handle the volatility of index option trading. That being said, the options that I bought are the OSX June 160 calls that are currently trading at $3,120 bid by $3,190 offer.
I don’t get cute on the execution price when I play these options and so I typically just pay the offer price. The June 160’s have about $2,300 in intrinsic value in them and about $900 in time value premium."
Chief Investment Officer
ETF Master Trader