Tag: European call option

  • When to Sell Option Call?

    When to Sell Option Call?

    If the trade is going in your favor or for the trade that is going against you – don’t wait until expiration to see what happens. Sell before.

    Fresh traders, particularly those with a little amount on the account, like to buy options. But do they understand all the rules? The vast of them somehow skip selling prior to the expiration date. The truth is that the call option could be sold at any time. Call options give you the right to buy some assets, you already know that. To know when to sell the option call, pay attention to several situations.

    Let’s say you own calls and you decide to let them expire worthlessly. That’s okay. Your decision. But if you forgot and the stock closes on the expiration date the options will automatically be exercised whenever it is “in-the-money” when the market closes.

    And it will be a problem when the next day comes. The next day, the day after the expiration date, the margin call will come. Where is the problem? When you buy an option call, you are buying the right to buy a stock. Did you know that? If you are new in the options trading it is likely you didn’t. And what happens? When margin call comes you have to pay for shares and you’ll be forced to sell your call options. So, it is better for you to sell your options calls before the expiration date.

    So, you have to close your trade before the expiration date.

    When you opened your position your aim was to make a profit, right? So, don’t wait for options to get too close to the expiration date because they will lose the value. As the expiry date is closer, the value is going down. To make a profit it is better to sell your options and close the trade. Of course, you may take a loss too but if you wait longer and as you are approaching the expiration date, the chances to avoid loss are almost zero.

    Avoid margin call

    Lett’s say you bought one call option. How to know when to sell option call? Don’t forget that one option controls 100 shares of stock. And let’s say the strike price is $30. If the stock closes at $30,03 your options will be automatically exercised and you’ll be the owner of 100 shares of stock. Further, your broker will send you a margin call if you don’t have a sufficient amount on your account to pay that stock. And what you have to do? You will be forced to sell the stock to close out your trade. More often, you will sell it below the exercise price. But it isn’t necessary to be your case. You can avoid this unpleasant situation. Just close out your open position before the expiration day. Before the market closes, of course.

    For a strike price, you can calculate the cost to buy a call option and the cost to use it. You can find plenty of websites with options quotes. All you have to do is to type a stock’s ticker symbol and get a quote. You will see a column with months arranged and with the options expiring that particular month. Remember, you can trade the option until the third Friday of the expiration month.

    Calculate options for a strike price

    Find your wanted strike price in the “strike” column. Strike prices are ordered from cheaper than the stock price to higher than the stock price. Suppose the stock’s price is $50 and the strike prices ranging from $20 to $70 in a $2 increase. And you want to calculate an option with a $60 strike price. And suppose you want to buy a call option with a $2 “ask” price.

    To calculate the whole price to buy one option contract you have to multiply the ask price by 100. In our example, it is $2 x 100 which is $200. No, it doesn’t amount to buying the stock, this amount of money you have to pay for the right to buy the stock. 

    Let’s go further. The next thing to do is to multiply the strike price by 100. That is an added amount you have to pay to use the option.

    $60 x 100 = $6,000

    This means you can buy 100 shares of stock for $6,000 before the expiration date.

    Use volatility forecast

    In general, volatility is extremely important when buying or selling options. Since “returning towards the mean” is especially noticeable on volatility, you can somehow easily forecast the volatility as it goes above a certain point or less than a certain point – it will, most likely, return towards the average volatility.

    You can check the VIX to measure market volatility. Learn here how to do it.

    Bottom line

    Don’t buy call options with the aim to own the stock when the options expire. Your goal has to be to buy a call option and profit when the stock price grows.  If call options expire in the money, you will end up paying a bigger amount to buy the stock. Much bigger than what you would have paid if you had bought the stock. If you want to hold the stock, buy it. Don’t play games with options. 

    And finally, one important note when it comes to questioning when to sell option call.

    The European-style options expire on the third Thursday of the month. The American options expire on the third Friday. Don’t forget about this time difference. This could result in huge financial losses for you.

    Forecast volatility, that’s a key ingredient in profiting from option trading.

  • A European Call option – What is it?

    A European Call option – What is it?

    A European call option - What is it?There are many differences between European and American styles in trading call options. Here are all.

    By Guy Avtalyon

    A European call option means an option for the right to buy a stock or an index at a certain price on a certain date. Notice the expression “on a certain date.” This “European style call option” is different from the “American style call option” that can be exercised at any time “BY a certain date.”

    A European call option provides the investor with the right to purchase an asset, while a put option provides the investor with a right to sell it.

    In other words, unlike an American option, the European option has no flexibility in the timing of exercise.

    Formula

    In theory, a European option has a lower value than an otherwise equivalent American option. It is because a European option does not enjoy the convenience that arises from the flexibility in the timing of exercise.

    Value of a European Call Option = max (0, Asset Price − Exercise Price)
    Value of a European Put Option = max (0, Exercise Price − Asset Price)

    Asset price is the price of the underlying financial asset at the exercise date.

    The exercise price is the price at which the option entitles its holder to sell or purchase the underlying financial asset.
    Some examples

    European call option

    To differentiate between a European call option and an equivalent American call option we have to compare them here.
    Let’s say, a trader bought 100 American call options stock. The option has an exercise price of $42 and an expiry date of 27 July 2018. The trader believes that stock price on 24th, 25th, and 26th of July is expected to be $43.5, $44.5, and $43.

    Assuming a trader is very confident in owns projections, what is the maximum can gain on the options and when should exercise them?

    Since trader bought American options, he/she can exercise them at any time before 27th. Based on the projections:

    Value on 24th = max [0, $43.5 – $42] = $1.5
    Value on 25th = max [0, $44.5 – $42] = $2.5
    Value on 26th = max [0, $43 – $42] = $1

    The trader should exercise the options on 25th and gain $2.5 per option.

    But, the trader bought European options, and he/she would have been able to exercise them only on 26th July 2018 for a gain of $1 per option.

    Assume that traders used European options instead of American options.

    Solution

    Since trader purchased European options which she can exercise only on the exercise date i.e. 26th July 2018 and not before, trader’s gain per option will be only $1 (i.e. option value at the exercise date = price of underlying asset ($43) minus exercise price ($42).

    If the trader had bought American options, he/she could have exercised them on 25th July 2018 (the day it offered maximum gain) for per option gain of $2 (= $44.5 − $42).

    Like their American Option counterparts, a European option is traded on an exchange. The contract will specify at least four variables.

    • Underlying Asset:  stock indexes, foreign currencies, as well as derivatives.
    • Premium: the price paid when an option is purchased or sold.
    • Strike Price: identifies the price at which the holder of the contract has a right to sell (put option) or buy (call option) the underlying asset.
    • Maturity Date: also referred to as the expiry date; the option no longer has any value if not exercised on this date.

    As is the American Options, European-style options also come in two basic forms:

    Call Options: also named calls. This contract gives the holder the right to purchase the asset at the strike price on the maturity date.

    Put Option: also named puts. The contract gives the holder the right to sell the asset at the strike price on the maturity date.

    Most stock or equity options in the U.S. are American Styles, whereas most index options traded in the U.S. are European style. Since you can’t actually “exercise an index option” and by the index, index options are cash-settled. Cash-settled means that your broker simply deposits the “in the money” amount at expiration.

    What does the European style option mean for the trader?

    It means that you are concerned ONLY with the price of the stock or index at its expiration. European style options tend to be cheaper than American style options because if a stock spike prior to expiration. An American style call option trader can profit on that increase in value. The European style option trader has to hope the price increase holds until expiration.

    When to buy a European Call Option

    If you think a stock price or index is going to go up, then you should buy a call option. Unluckily, you don’t get to select if you want to buy a European style option or an American style option. That decision is already made by the exchange that the option trades on. Most index options in the U.S are European style. Take a look at the chart below:

    Example of a European Call Option

    If you bought an S&P500 Index option, it would be a European style option. That means that you can only exercise the option on the expiration date. Of course, it is still an option, which means that you have the right but not the obligation to exercise it.

    Obviously, if you have a call option and the Index closes below the strike price on the expiration date then you would not exercise it. And that option would just expire worthlessly. Likewise, if you have a put option on the Index and the Index closes above the strike price on the expiration date then you would not exercise it. And that option would just expire worthlessly, too.
    Notice in the chart above that the S&P500 Index (SPX) is a European style while the S&P100 (OEX) is American style.

    In the U.S., most equity and index options contracts expire on the 3rd Friday of the month. Also, note that in the U.S. most contracts allow you to exercise your option at any time prior to the expiration date. In contrast, most European options only allow you to exercise the option on the expiration date.