In my previous missives on the Greeks of the option world, we have used most of our time focusing on Theta and Delta. In the real world of option trading, option prices are the themes of three primal forces: price of the underlying, implied volatility. , And time to expiration Delta and theta address the first of these two primal forces. The third primal force, implied volatility, is far and away the least known by newcomers to the option trading world. However, while it is generally not respected or even known by many new to trading options, it typically is the more frequently unrecognized force resulting in is the reason for significant trading capital deterioration.
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Options Contracts re-sale?Let's say I'm the seller and write 1 contract for .57 ($57), I write this call when the option is $2 out of the money (so the intrinsic value of the option is lower). Let's say the next day the option gets $1 more closer to the strike price therefore raising the intrinsic value of the option to let's say 1.00 ($100). Could I close/cancel the option contract I wrote out at .57 ($57) and write a new/different one at the new $1.00 option price? If I did close out my option contract would I have to automatically exercise and sell the shares to the buyer? My question is how could I take advantage of the new higher option price (from .57 to 1.00) ?
Everything Gianpaolo a said in his answer is accurate, but I am not sure if he gave enough detail to be clear. Let me try rephrasing the same information to see if I can make it clearer. "Let's say I'm the seller and write 1 contract for .57 ($57), I write this call when the option is $2 out of the money (so the intrinsic value of the option is lower)." The intrinsic value of an option is the amount that it is in the money, so an out of the money has no intrinsic value. The value that is does have is known as "extrinsic" or "time" value. The sum of the intrinsic value (if any) and the time value is the premium paid when the option is traded. " Let's say the next day the option gets $1 more closer to the strike price therefore raising the intrinsic value of the option to let's say 1.00 ($100)." The option never gets closer to the strike price. Only the stock can do that. So I am reading this sentence as "Let's say the next day the stock price goes up $1.00 and the option premium goes up from $0.43 to $1.00. "Could I close/cancel the option contract I wrote out at .57 ($57) and write a new/different one at the new $1.00 option price?" You can close the option contract that you wrote at $0.57 but it will cost you $1.00 ($100) to close it. (Use a "buy to close" or "buy to cover" transaction.) You can then write another contract for $1.00, but if you do that you will be in the same position that you were at before you closed the original contract. Buying a contract for $100 and then selling the same contract for $100 does not change your position at the end of the day, it only increases the amount you pay in commissions. "If I did close out my option contract would I have to automatically exercise and sell the shares to the buyer?" No. When you buy to close (cover) your obligation as an option writer is simply transfered to the new writer. "My question is how could I take advantage of the new higher option price (from .57 to 1.00) ?" Since you were short the option and the price went up, you will have an unrealized loss when the option price increases. You cannot do anything to eliminate that loss. Closing the contract would simply covert the unrealized loss to a realized loss. The only way to "take advantage" of the higher price is to write another contract at the higher price, but if you do that you are also increasing the amount of risk you are accepting. Before you decide to increase the amount of risk you accept, you should remember the stock has already fooled you by going up after you sold the first call option.
If your writeing a call option, you expect the underlying stock to remain below the strike. To close out the option you wrote you need to go out and purchase that option on the market. So if you wrote the contract for .57 and the option went up in value to $1, if you wanted to close that contract out you would end up losing .43. Because you had credit of .57, but you paid $1 to close out the contract. At this point you could go out and rewrite the contract at $1. If your writeing contracts please own the underlying security, you dont want to be caught naked. Also, the call option has no intrinsic value until the underlying security is above the strike, until that point it is all time value.
As long as there is a willing buyer and a willing seller, you can do whatever you want, as long as it's legal. Don't forget that you buy at the asked price and sell at the bid price and they never are the same. If you buy back your contract for $1, you won't be able to sell another one for $1. The new one will cost more than $1. You don't have to exercise the option. Options contracts can be bought and sold up until the expiration date.
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THE bookshelves in the conference room of Tweedy, Browne & Company are lined with financial history. Dry securities references, some of them filigreed and bound in cracked brown leather, date back to 1939. These were the books that Howard Browne, a co-founder, consulted when he bought and sold stocks for the likes of Benjamin Graham, the father of value investing and the firm’s biggest customer in the 1930′s and 1940′s. Later, in the 1960′s, Tweedy, Browne brokered for Warren E. Buffett, …