The sooner the price rise occurs, the better. It means less time for theta to
eat away profits. If Kim must hold the position for the entire three weeks,
she needs a good pop in the stock to make it worth her while. At a $37 share
price, the call is worth about 0.50, assuming all other market influences
remain constant. That’s about a 150 percent profit. At $38, Exhibit 4.9
reveals the call value to be 1.04. That’s a 420 percent profit.
On one hand, it’s hard for a trader like Kim not to get excited about the
prospect of making 420 percent on an 8 percent move in a stock. On the
other hand, Kim has to put things in perspective. When the position is
established, the call has a 0.185 delta. By the trader’s definition of delta,
that means the call is estimated to have about an 18.5 percent chance of
expiring in-the-money. More than four out of five times, this position will
be trading below the strike at expiration.
Although Kim is not likely to hold the position until expiration, this
observation tells her something: she’s starting in the hole. She is more likely
to lose than to win. She needs to be compensated well for her risk on the
winners to make up for the more prevalent losers.
Buying OTM calls can be considered more speculative than buying ITM
or ATM calls. Unlike what the at-expiration diagrams would lead one to
believe, OTM calls are not simply about direction. There’s a bit more to it.
They are really about gamma, time, and the magnitude of the stock’s move