Disclaimer: We here at skillbuilderdad.com are neither financial advisors nor professionals. This article expresses the opinions from the personnel at skillbuilderdad.com, and is for inspirational and educational purposes only. The investment decisions you choose to make are 100% YOUR responsibility. Investing of any kind involves risk, and options trading can involve BIG risk with BIG losses. It is recommend that you consult a financial advisor before making any trades.
Wow, sometimes I cannot believe the power of trading options. This week, I witnessed one of my option contracts double in value overnight! If you have read our article about buying lottery tickets on the stock market here, then you may know what I am talking about. Below is a case study based on the referenced strategy.
Let’s dive right into this real life example. On December 18 2020, I purchased a single Call option on Activision Blizzard (ATVI), a popular producer of video games. The stock was trading at $88.85/share, and my Call option of choice was to buy near the stock trading price, also known as the strike price. I chose a strike price of 90. My next choice was to make sure the contract did not expire too early, because I wanted to give it time to rise in value. I chose the expiration date to be March 19, 2021. This combination narrows it down to a specific contract, which can be written in shorthand as ATVI MAR’19 21 90 CALL. I purchased this option for $545. You can also say that I bought a lottery ticket for this amount, in hopes that ATVI would go up in value.
Lottery Tickets
Since the stock traded below my strike price, I knew that if ATVI stock did not rise above $90/share, my lottery ticket would expire worthless. The option trading gurus also know this as a situation called being “Out-of-The-Money,” or OTM. They’re right, I would definitely be “out of money” on this trade if the stock expired worthless. For the next few weeks, ATVI stock slowly rose in value, and it was enough to keep my option value near break-even. As you may know, this is because of the nature of options, where they have both intrinsic value, and time value. Intrinsic value goes up and down with the stock price, and time value erodes as the contract approaches expiration.
The Overnight Rise
Fast-forward to February 4, 2021 and ATVI released their earnings report for the 4th quarter of 2020, just after the market closed. Headline news for their earnings can be found stating: “Activision Blizzard beats earnings expectations, ‘Call of Duty’ dominates.” As we all know, good news usually increases the value of the stock as more people are willing to buy into a company that is smashing expectations. This is good news for me, because the stock rose from around $92/share to just over $100/share OVERNIGHT!!!
So What? It’s less than a 10% rise in stock value
At this point if I owned 100 shares of ATVI, my investment would have risen from $9200 to $10,000 per share overnight, which is less than a 10% increase, so it should not be something to get excited about, right? Well in my situation, I did not own thousands of dollars worth of ATVI, because I did not want to risk that much of my portfolio on a single speculative stock. Instead, I bought a contract with the option to purchase 100 ATVI shares if my heart desired. This would be known as exercising the option if I chose to do this, but instead of exercising contracts, I usually choose to simply buy a contract, wait for it to rise in value (or lose value on the contrary), and then sell the contract back into the market for a profit. Now that you know my strategy, let’s look at the option contract and see what it did overnight. Below is a screenshot of the contract* and as you can see, the value of the option doubled in value from around $600 to over $1200, a 100%+ increase OVERNIGHT!!!
*Values show as 1/100th of actual, so move the decimal to the right by 2 digits to get to “dollar value”. Unfortunately, this is the nature of viewing anything options-related.
Yea but…the 100 shares of stock made more money than the contract, right?
Most certainly. Overnight, the 100 shares increased by $800 ($10,000-$9,200), and the option contract increased by $600 ($1200-$600). If you focus on dollars, the stock wins out in this situation, however I prefer to focus on percent increase of investment, because it takes into account your dollars that were originally invested. Instead of having almost $10,000 stuck in a video game stock, I was able to buy an options contract for a fraction of the cost and double my money. Less risk, more reward. This is the power of options trading, my friend.
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Further Reading (Bonus Content)
The above example describes the trade as an overnight increase, with rounded numbers to keep the example simplified. If you want to know how the gains look from the beginning of the trade, see the table below. It shows a comparison of the entire trade from entry to exit, if you were to have owned 100 shares of the stock versus the single options contract.
Disclaimer: We here at skillbuilderdad.com are neither financial advisors nor professionals. This article expresses the opinions from the personnel at skillbuilderdad.com, and is for inspirational and educational purposes only. The investment decisions you choose to make are 100% YOUR responsibility. Investing of any kind involves risk, and options trading can involve BIG risk with BIG losses. It is recommend that you consult a financial advisor before making any trades.