Need help understanding aspects of options

[crushie]

Hi there,
I've gained a good understanding of the theory behind Options but I've got a few outstanding issues that I would really like some help with.

Firstly, is there a metric that says how many options of a particular option code are available to purchase? I'm finding option codes in the search on the asx website and noting the bid, offer and all the other statistics but I'm trying to figure out how to determine that if I put an order for say, $500 on a particular option code, for example FMGLI9, that the order will pretty much go through guaranteed or if I have to check somewhere whether or not they are available to buy.

Second question sort of spins off the first one, Sometimes I've seen call options that have a much lower exercise price than the current share price. What stops a person from buying the options at $3.50 exercise price then immediately exercising them and selling them at the current price of $5?

Lastly, I'll be using Etrade to buy options once I'm confident. When I'm placing an order, is the net debit just the option price times how many options I want to buy?

Thanks very much for your help I do appreciate it.

 

[burglar]

... What stops a person from buying the options at $3.50 exercise price then immediately exercising them and selling them at the current price of $5? ...

Don't quote me ... but I believe that exercising options is a time consuming process.

PS Options are sharp instruments, handle with care!

 

[village idiot]

hey crushie

eto's are a real market, and there has to be someone willing to take the other side. For liquid options (tending to be nearer the money) if you can see a bid and a differnt offer price on ASX site , that means that twenty minutes ago there were real bid and offers in the system, which can be put in there by either market makers or retail punters. From the ASX website we dont know how many lots are available to trade at that price, it might be only 1 lot if it is a retail punter. In Interactive brokers you can look at the market depth to find out, but no idea about etrade. Usually you can deal somewhere inside the spread, even crossing the mid price if anothe rpunter is around
For illiquid options, there is often no bid or offer in the market place. In this case, the ASX puts some sort of theoretical value in for both bid and offer (ie they are the same). This is the case with FMGLI9 right now. you certainly could not necessarily trade at that price.
That does not mean you cannot trade at all , but it means you will probably only get a market maker to take the other side, which means you are going to have to pay his spread. To find out what that is, try putting in a limit order to buy at a price you are confident is below the fair price. Often a two way quote will then appear as a bid offer (if you have access to real time prices ie not the ASX). Often you can deal inside that if its wide , but if it is a market maker he wants a profit. that is why illiquid options are illiquid

 

[village idiot]

Second question sort of spins off the first one, Sometimes I've seen call options that have a much lower exercise price than the current share price. What stops a person from buying the options at $3.50 exercise price then immediately exercising them and selling them at the current price of $5?

because you would always have to pay at least as much as the difference between the two prices
eg your option is a 390 call, fmg currently 494/95, so the diff is 104/105. No one will ever sell you the option for less than 104 for the reason you suggest - it would be like picking up free money which doesnt often happen in the markets. The fair value mid price on the ASX site (because there arent any real bid/offers in the market) is 1.11, which is 1.05 intrinsic + 6c time value. In reallife you would probably pay 1.15 ish for it.

 

[village idiot]

if you have another look once it refreshes you will see that it is now bid .99 offered at 1.18. that is me putting a bid and offer (for one contract each) to see if I can flush out a market maker, but it didnt happen. So not much chance of transacting at any reasnable price

i will take the other side though if you want to pay me 1.18

 

[wayneL]

Hi there,
I've gained a good understanding of the theory behind Options but I've got a few outstanding issues that I would really like some help with.

Firstly, is there a metric that says how many options of a particular option code are available to purchase? I'm finding option codes in the search on the asx website and noting the bid, offer and all the other statistics but I'm trying to figure out how to determine that if I put an order for say, $500 on a particular option code, for example FMGLI9, that the order will pretty much go through guaranteed or if I have to check somewhere whether or not they are available to buy.

As options are a contract there is, in theory, no limit to the number of contracts you can buy or sell. However, as with all contracts you need a counterparty to deal with, IOW someone willing to open the contracts with you or sell you existing contracts.

This will depend on market maker obligations and/or traders active in that option series.

Second question sort of spins off the first one, Sometimes I've seen call options that have a much lower exercise price than the current share price. What stops a person from buying the options at $3.50 exercise price then immediately exercising them and selling them at the current price of $5?

Those in the money options will have intrinsic value, in your example above the intrinsic value will be $1.50 and no body will sell you those options at less than intrinsic value.

In addition, if the options have extrinsic value (value in excess of intrinsic value), you will immediately lose that extrinsic value with early exercise.

e.g.

xyz is trading at $10.00

$7.00 call options are trading at $3.75 (75c extrinsic value)

Buy the call options @ $3.75 and immediately exercise, means you have the right to buy the shares for $7.00

Pay $7.00 for the shares, plus the $3.75 you paid for the option.

You now own $10.00 shares that cost you $7.00 + $3.75 = $10.75

You just lost $0.75, the extrinsic value of the option.

Lastly, I'll be using Etrade to buy options once I'm confident. When I'm placing an order, is the net debit just the option price times how many options I want to buy?

Thanks very much for your help I do appreciate it.

Yes. Quoted price x contract size x number of contracts.

<edit to add> was typing this out when no village idiot posted.

 

[crushie]

Thanks wayneL and Village I do appreciate the help.

I'm guessing from what i'm reading that actually exercising the option is not often a part of ones trading strategy?

 

[wayneL]

Thanks wayneL and Village I do appreciate the help.

I'm guessing from what i'm reading that actually exercising the option is not often a part of ones trading strategy?

It depends on what you're trying to do. But if exercising, only do so when financially advantageous... very rarely before expiry or unless a dividend is involved and is greater than extrinsic value.

 

[village idiot]

it can be, sometimes, if that is the most efficient way to exit the trade (or you actually want to aquire or dispose of some shares) , and would only really happen when time value is nothing or next to it. I can pretty much guarantee however that it will never be very efficient if you pay Etrade's ( or any other Australian broker's) extortionate brokerage - they seem to charge 0.22% (min $45) to exercise, which is twice as much as if you bought the stock in the regular fashion with them. For what, Etrade?

In fact i dont see how you could ever have an edge paying min of $45 or .55%/.22% for every entry, exit, leg of a spread, or exercise.

 

[crushie]

Well I'd most of all like to learn about leverage. You see I have about $15,000 in savings but my wife would murder me if I risked it all in the markets. I have about $1000 to work with instead. I was thinking that rather than buy $1000 worth of an underlying security I could buy $1000 worth of call options. If I have the option to buy lets say, 1500 of the product at 10 per share and the price has risen to $15 before the expiry date I could rationalize using the $15,000 to exercise the options because it's a sure thing.

Would this work or are Options structured in a way where just selling them again rather than exercising them would result in the same or better profits by that point?

 

[wayneL]

Well I'd most of all like to learn about leverage. You see I have about $15,000 in savings but my wife would murder me if I risked it all in the markets. I have about $1000 to work with instead. I was thinking that rather than buy $1000 worth of an underlying security I could buy $1000 worth of call options. If I have the option to buy lets say, 1500 of the product at 10 per share and the price has risen to $15 before the expiry date I could rationalize using the $15,000 to exercise the options because it's a sure thing.

Would this work or are Options structured in a way where just selling them again rather than exercising them would result in the same or better profits by that point?

It depends. You have to do your sums at that point, considering slippage and brokerage in the transactions.

As a general rule of thumb though, unless you want to keep the shares, you're better of just closing out he options.

 

[village idiot]

if you actually wanted to keep the shares, and the options were deep in the money near expiry, it would be appropriate to exercise the options.

If you didnt actually want the shares, you just wanted the profit so you would have to sell the shares again to realise it, you would probably be better off selling the option for what you could get ( intrinsic value less market makers profit), as the costs to exercise then resell would probably outweigh the mm spread.



disclaimer; nothing in these replies should be taken as encouragement to buy $1000 worth of options with the expectation of them becoming worth $7000. especially with money the missus is going to give you grief over.

 

[crushie]

if you actually wanted to keep the shares, and the options were deep in the money near expiry, it would be appropriate to exercise the options.

If you didnt actually want the shares, you just wanted the profit so you would have to sell the shares again to realise it, you would probably be better off selling the option for what you could get ( intrinsic value less market makers profit), as the costs to exercise then resell would probably outweigh the mm spread.



disclaimer; nothing in these replies should be taken as encouragement to buy $1000 worth of options with the expectation of them becoming worth $7000. especially with money the missus is going to give you grief over.

Yeah mate it's okay I won't do anything too risky. I'd never hear the end of it if I lost the $1000.

 

[crushie]

I do have one more question. An example for this could be the option FMGXB8.
The bid and offer are .135 and .145 respectively.

Is this per share? or per option i.e per 100 shares? Thanks for that.

 

[village idiot]

I do have one more question. An example for this could be the option FMGXB8.
The bid and offer are .135 and .145 respectively.

Is this per share? or per option i.e per 100 shares? Thanks for that.

it is per share, in $. each contract is usually 100 shares so 1 contract = $0.145*100 = $14.50

 

[JLM Financial]

There is a great course available which covers the basics of options and warrants in Australia. It's called Accredited Derivatives Advisory Level 1. The level 2 is slightly more complex and discussed synthetics and several option spreads. When I did the course it was through Kaplan, not sure if they still offer the course.
PM if you want more info.

 

[OpenMind]

Yeah mate it's okay I won't do anything too risky. I'd never hear the end of it if I lost the $1000.

I'm in the same boat as you Crushie

I'm learning about this now and want to get into this Eyes Wide Open and take calculated risks...

Sometimes ignorance is Bliss