38 lines
1.8 KiB
Plaintext
38 lines
1.8 KiB
Plaintext
64 • The Intelligent Option Investor
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although it is indeed possible to make money using these types of strategies,
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because multiple options must be transacted at one time (in order to control
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directional risk), and because in the course of one year many similar trades
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will need to be made, after you pay the transaction costs and assuming that
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you will not be able to consistently win these bets, the returns you stand to
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make using these strategies are low when one accounts for the risk undertaken.
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Of course, because this style of option trading benefits brokers by
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allowing them to profit from the bid-ask spread and from a fee on each
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transaction, they tend to encourage clients to trade in this way. What is
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good for the goose is most definitely not good for the gander in the case of
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brokers and investors, so, in general, strategies that will benefit the investor
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relatively more than they benefit the investor’s broker—like the intelligent
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option investing we will discuss in Part III—are greatly preferable.
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The two drivers that have the most profound day-to-day impact
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on option prices are the ones we have already discussed: a change in the
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strike–stock price ratio and a change in forward volatility expectations.
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However, over the life of a contract, the most consistent driver of option
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value change is time to expiration. We discuss this factor next.
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Changing Time-to-Expiration Assumptions
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To see why time to expiration is important to option pricing, let us leave
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our volatility assumptions fixed at 20 percent per year and assume that we
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are buying a call option struck at $60 and expiring in two years. First, let’s
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look at our base diagram—two years to expiration:
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Advanced Building Corp. (ABC)
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5/18/2012 5/20/2013 249 499 749 999
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100
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90
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80
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70
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60
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50
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40
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30
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20
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Date/Day Count
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Stock Price
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GREEN |