What price?

[JonnyT]

Hi folks,

Lets say I have a swing trading strategy for the FTSE.

Over the next three trading days I expect FTSE to at some point reach 150 points above its current close.

The 18th July call options are priced as follows:

4275 5 8
4225 10 14
4075 55.5 63.5

In the event I was right, what prices would these various options be expected to be trading at?

Any help appreciated. Is there a spreadsheet for this kind of thing freely available?

Thanks

JonnyT

 

[darrenf]

Am not an expert on the pricing of options but I did look into option spread bets ages ago. I seem to remember that cantor index used to offer FTSE options SB's if that is any help.

 

[Trader333]

I believe that RogerM is the resident expert on options and it may be worth contacting him.


Paul

 

[oatman]

You would need a formula to take in to account the effect of time erosion and the volatility.
I'm trying to find something now.
edit. found this, can't look now going out
http://www.options-inc.com/master/master.html
Cheers

 

[Helenqu]

Roger is doing a session on Index Options at next weeks traders day.

 

[JonnyT]

Helen,

I would have come to the traders day, but unfortunately I'm going to be playing with the kids on a beach in Spain.

JonnyT

 

[Helenqu]

|'ll take notes for you

Have fun!

 

[RogerM]

JonnyT - with the FTSE100 at around 4055, the prices for all 3 options you have listed represent time value only. Therefore if the FTSE is below the strike price of each option by 18th July (expiry), then they will expire worthless because at expiry there is no time value left. At expiry there is intrinsic value only. If the index rises 150 points to (say) 4200 by expiry, then the 4225's and the 4275's will both expire worthless because their strike prices will still be above the FTSE. The 4075's will be worth 125 ( i.e. 4200 - 4075).

What are they worth in the meantime? This will depend primarily on the level of the FTSE, time to expiry and volatility. Over a 3 day period, 3 weeks from expiry, the fall in time value will be small and could easily be offset by an increase in volatility. Implied volatility (IV) at the moment is very low ( the lowest I have ever seen) so an increase in IV would be almost certain if there is a 3 day increase of 150 points.

The rate of change of an option's value compared to a change in the value of the underlying instrument, in this case the FTSE 100, is measured by delta. As a rule of thumb, the delta of an at-the-money (ATM) option is 0.5 - i.e. the option changes in value by 0.5 for each point change in the ftse. This will be true for values 30 - 40 points either side of the FTSE this far from expiry. Delta increases as the option goes into-the-money so that when it is deep-in-the-money it approaches 1.0 (i.e. the option value changes point for point with the ftse). A deep out-of-the-money (OTM) option will have a delta approaching 0 - e.g. a July 6225 call is unlikely to acquire any intrinsic value even if the FTSE rises 500 points, and this is reflected in the price which will hardly change. As you approach expiry, the delta of an in-the-money option increases at any given level, and the delta of an OTM option reduces, making the rate of change in value very much more volatile. Your 4075 call approximates to an ATM option, so it will have a delta of approx 0.5 - i.e. the option will rise by 5 points for each 10 point rise in the FTSE.

As for how much the value of each of your other quoted options will change in value over 3 days, this is best done using option software. I use the free model at http://www.hoadley.net/options

The current IV of the 4225 calls is only 16.4%, giving a delta at current prices of 0.17. The 4275's have a delta of about 0.11, so the option will increase in value by only 1.1 for each 10 point rise in the FTSE. But remember that this rate of change will accelerate as the FTSE continues to rise, and therefore delta rises.

As a generalisation, it is very tough to make money purely by buying an option unless you capture a sizeable move quickly. That is why I always try to cover at least part of the cost by selling options as part of a spread strategy.

HTH

 

[darrenf]

Hmmmmm!

Now I remember why I decided not to bother with options!

Too much extra to think about on top of entry/exit/stops/money management etc!

Far too complex for a simpleton like me. Just couldn't get my head round options. A typicall Yorkshire man- "I know what I like and I like what I know" and options just isn't it for me.

 

[RogerM]

The free on-line calculator found by Oatman is very good, and is a great "what if" tool..

http://www.options-inc.com/free_tools/calculator.htm

This shows that for the 4225 calls, bought for 14 on 27.06.03 with 21 days to expiry and with the FTSE at 4055, IV of 16.6% and an interest rate of 3%, they will be worth 53 if the FTSE rises to 4200 after 3 days, provided there is no change in volatility.

To show the effect of a change in IV, if the IV rose in the same time to 20% (from 16.6%) then the price should be 65.6 - a very significant difference. This is yet another illustration of why you should look at options as a play on volatility rather than just direction.

 

[RogerM]

darrenf - I sympathise. It took me a long time before the penny dropped for me. The 2 main additional considerations are those of time and volatility.

Time value always works in favour of the seller and against the buyer. Volatility can work for either. Rising volatility works for the buyer (i.e. buy when IV is low but rising), and falling volatility for the seller (i.e. sell when IV is high and falling).

Therefore in addition to getting a gain due to correctly calling the direction, you can also gain by calling the change of volatility correctly. And you can lose on both counts as well of course! But whereas a market can continue to fall or rise indefinitely, volatility can't. Where options score, IMHO, is that you can devise a strategy to suit any scenario you care to mention, and set the risk level to suit your own individual style.

 

[Trader333]

RogerM,

I would have thought that a good options strategy would be to sell an out of the money call option on say Halifax if you own 1000 shares or more. This is a risk free strategy in that if the strike price is hit then you have to sell the shares but that would still be at a profit and if the strike price is not hit then you have the money from selling the option and no liability. To me its made money for doing nothing.

Am I right in thinking this ?

Cheers


Paul

 

[JonnyT]

Thanks Roger,

I was considering whether it might be prudend to use an option for a short term trade or a future, given that I think FTSE will hit 4200+ in the next three days.

From the calulators the Option would seem the better bet, giving a profit of 4X potential loss.

JonnyT

 

[RogerM]

Paul - what you are proposing is a covered call, and is, IMHO, a safer strategy than holding the shares on their own.

As I write, HBOS is at 792. The October 850 calls can be sold for 21.5 (£215 per contract of 1000 shares). You keep the premium taken under all circumstances. If the shares are below 850 at expiry in October, then you keep the shares. If the shares rise to (say) 900 by expiry, then you will have the shares called away at 850, although you still keep the premium taken of 21.5, making the effective disposal price 871.5, so you have missed out on some of the gain.

If the price falls to (say) 750 and you decide to sell them, then you still keep the premium, making the effective disposal price 771.5.

If you can take a premium of 20 every 3 months, then you will take in 80 during the year, or about 10% of the value of the shares. So if the shares have a dividend yield of say 4% and rise in value by 5% over the 12 month period, then the overall return will be 10% + 4% + 5% = 19% of which over half comes from the option premiums taken in.

If you decide to sell the shares, then you should consider buying back the options as well. Once the shares are sold, the calls become uncovered and in the event of a runaway rally, or a take-over bid at (say) 1200, then you will have to deliver the shares at the strike price, 850 in this case, and the only place you will be able to get them is by buying them in the open market at 1200, and then delivering them for 850 - not a great money-making strategy!

Although I have not done it for some time (perhaps I should start again!), covered calls have been a great low risk strategy. I have also used the premiums taken in by selling calls to buy a put below the price before going on holiday so that I am protected against a major fall in my absence. If you match the prices, then the strategy costs you nothing. The best example was when I held Abbey National shares at 702 last Sept. I sold April 2003 750 calls for 53 and used the premium to buy April 600 puts for 44, leaving me with a credit of 9, and I was protected against falls below 600. When the price collapsed to 512 I was protected against falls below 600. I sold the shares at 623 for a loss of 81p per share. I bought back the calls for next to nothing, and held onto the puts which I held until April when I sold them for 212 which more than compensated for the 81p loss.

An excellent site on covered call strategies in the UK try :-

http://www.investorprofit.com

 

[Trader333]

Roger,

Thanks for your reply, your knowledge on options is second to none.

Cheers


Paul