Closing Prices – How can we use These
It must be made clear that options prices do of course move during the course of the trading day. These may or may NOT be optimum prices. They are good enough for our purposes, so let’s proceed.
There is a much talked about concept of the ‘Santa rally’. Perhaps fund managers are buying to make their portfolios look better. Perhaps there’s a feel good factor. ( If you doubt the market runs on emotions, carry on). So let’s assume we are going to trade this rally. We can buy unlimited profits FTSE closed around 6775 so these calls are OTM( out of the money). Meaning that if they expired today they would have no value. The 7000 call is 18.5(£185 per lot) They ONLY have time value,which as we know, decays with time -THETA .So if we are going to limit time decay we will sell another option. Let’s BUY the 7000 call for 18.5, and look at SELLING the 7050 call, or the 7100 call. What’s the difference? Max reward for the 7000/7050= 50 minus premium paid.(18.5-9.5=9) =41. 7000/7100 max reward=100 minus premium paid(18.5-5.5=13)=87
So Which Trade Is Best?
I don’t have a crystal ball, but let’s say you believe FTSE wil be over 7100 by expiry on December 16th then pay a bit more(13) Should you fancy less risk/reward go for the possibly higher probability/ lower profit trade and pay 9. Now here’s a thing. Some people use the option’s delta as a proxy for its likelihood of expiry in the money(Delta of 0.50= ATM,or at the money).
Three Wise Choices?
So then- possible trades for the Santa Rally
– buy the naked 7000 call for 18.5(£185) profit unlimited
buy the 7000call and sell the 7050 call for 9 (£90), profit limited or
buy 7000call and sell 7100call for 13(£130)profit limited
Remember when we trades spreads,the maximum value is the difference between the 2 strikes
