Q & A. Did I Do Something Wrong?

Hi Mark,

I bought 1 contract on FTQKZ at the ask price of $8.90.  I knew the last trade was at $10.50, and I
didn't think this mattered, because I was going off the bid ask spread. When I
received my order as being filled it said I all ready LOST $3.74 on my trade.
What did I do wrong, and where can you tell me how to do it right?

Mike

 

Hello Mike,

FTQKZ
is the First Third Bank Nov 2.50 call.

1)
You are correct; the last trade does not matter.

2)
Using the current bid/ask spread is the right way to determine how much to bid
for the option you want to buy.

3)
You did nothing wrong, except for something mentioned below.

4)
As far as I am concerned, it's impossible for you to have lost $374 per contract
– especially losing it immediately. That leads me to conclude that your broker
made an error in determining the price at which the option was 'marked' (valued
at end of day). 

·       
This is an option that is easy to value. It's
so deep in the money that it has little or no time value. Thus, the end of day
value (the value that appears on your daily statement) is essentially the
intrinsic value of the option (stock price minus strike price). Right now, the
stock is $14.63 and the value of your call is $12.13.

 

·       
If you paid $8.90, then the stock would have
to be trading near $11.40 ($8.90 + $2.50). 
The stock hasn’t been that low for awhile.  Did you buy this option one month ago and are
first asking about the trade now?  I think
it’s much more likely you may have made an error.  It’s possible you intended to buy the FTQKZ,
but clicked on FTQKA (the Nov 5 call) instead. 
Check your positions to be certain you really own the Nov 2.50 call.  It’s unlikely you made this error, but it’s
also unlikely your broker’s pricing of the option was so incorrect.

As
an aside, I believe you made a mistake buying this call option. It saved you
very little cash compared with buying stock. One of the reasons for buying
calls is to cut risk in case the stock declines rapidly. This option would save
you nothing on a stock decline, because it's so deep in the money. Furthermore,
you subjected yourself to a wide bid/ask spread when you bought the call (the
market in the stock is MUCH narrower) and will face that same bid/ask spread
when you decide to sell the option. And I'll wager that your broker charges a
higher commission to buy one call than it does to buy 100 shares.  Buying deep in the money options has its
advantages, but not when the strike price is so low.

Mark

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4 Responses to Q & A. Did I Do Something Wrong?

  1. Roland 08/24/2008 at 9:06 AM #

    Mark,
    Love your blog.
    You have mentioned that you are not good at picking market direction. I can relate to that. But I would think there are times when it would not be wise to be trading a market neutral strategy.

  2. Mark 08/24/2008 at 7:31 PM #

    Roland,
    There is more than one market neutral strategy. Some are easy to understand are are appropriate for rookies. Others are more complicated and can be used by more experienced traders.
    But for me, I prefer not to be leaning long or short and ‘market neutral’ is my comfort zone.
    If a trader anticipates a large market move, he/she can buy straddles or strangles, instead of iron condors. There are also back spreads in which the trader buys more options than are sold. These positions profit from a huge move and they are all market-neutral methods.
    Perhaps you mean to say that it’s not best to be selling option premium all the time. That’s a different story.
    Predicting the market is still a difficult game for the vast majority. But there is an option strategy that will profit under any specific market conditions – and if you are willing to wager on the accuracy of your prediction, you can adopt an appropriate strategy.
    Mark

  3. Roland 08/26/2008 at 7:33 AM #

    Mark,
    I appreciate how difficult it is to pick market direction. I certainly can’t do it.
    Do you do any type of market analysis such as support and resistance or sentiment?

  4. Mark 08/26/2008 at 8:27 AM #

    Roland,
    Sorry, but I don’t use any.
    I do look at point and figure charts occasionally
    (http://stockcharts.com)
    to get an overall picture, but I don’t use any other charts.
    Mark