LogFAQs > #957025167

Forceful_Dragon posted...

I feel like i need more information about what exactly is happening.

"I had sold $30 calls that expired in 2 weeks and bought $30 calls that expired in 3 months"

So just to clarify this means that

1) Someone paid you X for a $30 call that expires in 2 weeks.
and
2) You paid someone else Y for a $30 call that expires in 3 months.

And then what? 2 weeks elapses and the calls are getting exercised? Or the positions are being closed before the 2 weeks even happens?

And did you already own the underlying stock going in or are you having to purchase them at cost to sell to someone else for $30? Is that where the money is being lost?

I'm just trying to find where your benefit in the scenario is supposed to materialize. Is it from selling off your 3 month option to someone else?

I'm still in the 'accumulate wealth' phase of investing before I have enough money to play with stock options so I have only a basic understanding of them.

So I want to clarify before I post this, this is total plum theory and its possible this isn't the optimal way of doing this. I've made a lot of money doing it.... most of the time.

So here's the scenario: A meme stock shoots up from $30 to $60. You know historically meme stocks eventually fall back to earth as people lose interest so you want to bet on it going down. You have a few options

1. You could just short the stock, but that requires you to borrow money and you have high risk if the stock keeps soaring
2. You could buy at the money or out of the money options that it would go down, but those are ticking time bombs and could be extremely expensive
3. You can do what I did, and buy long term calls way in the money, and sell short term calls at the same price.

Why do you do this? Because options have two sources of value

1. The value of the underlying stock. Or in other words, if you have an option for $50, and the stock is $100, the option is worth at least $50, the difference.
2. The time value of the option. If the option expires in a month then its worth more than if it expires in a week because American options can always be excercised early.

The strategy is to buy long term and sell short term options where the value of #2 is pretty much zero. You can think of it this way, for an option way in the money, when the option expires is fairly irrelevant. It could expire now or in a month and the options is still going to be the price of the stock - the price of the option.

BUT

If the stock decreases sharply in price then the value of #2 starts increasing. Suddenly it starts to matter if the stock has time value left as the stock price inches closer to the option price.

What this means is the spread between the option you bought and the option you sold starts to widen.

In theory if the stock doesn't move much or goes the wrong direction, you will be out prety much nothing. You bought something that the option market valued to be nearly worthless, and it still is nearly worthless.

But if it moves in the direction you think it is going to then you start making a lot of money as your worthless spreads start exponentially increasing in value.

---

https://pbs.twimg.com/media/BdWiElvIQAAQpBt.jpg