by Dawn Pennington 09/03/08
One of the most-frequently asked questions I hear is, "The stock is trading above the strike price of a call option I've bought -- so why isn't my option profitable?"
In most cases, if a stock is trading at $55 and you are long call options at the $50 strike, your option will be in-the-money and, thus, valuable whether you want to sell it at market or exercise your right to purchase shares at $50.
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Under ideal circumstances, if the stock price has exceeded the option's exercise price, you've become the proud holder of an in-the-money call option that can be exercised for stock or closed directly for a profit.
DIAL 'V' FOR 'VOLATILITY'
There are a number of factors that influence an option's price -- volatility is oftentimes a culprit, because the more volatility exists in the broader market (or in a particular sector or in a company's shares) at a given time, the steeper the option premium you might pay to initiate a trade.
Timing (i.e., when you initiate a trade) of your purchase goes beyond volatility. For example, if you buy a call with a $50 exercise price when the stock is trading at $45, the option should be significantly cheaper than if you buy it when the stock is trading at $52.
Buying an out-of-the-money option, in this case (for example, buying the call option with the $50 strike price, with shares trading at $45), means that you're projecting the stock will make a dramatic spike during the life of your contract.
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Relatively speaking, though, a $5 jump in an actively traded stock might not be considered a dramatic move. But if you're looking for the stock to move that much in a month, with no potentially positive catalysts on the horizon such as an earnings announcement, what started out as an inexpensive bet might turn into a big loss.
Read This Before You Buy Another Stock
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If you are familiar with buying calls and puts, we'll show you how to buy them even cheaper.
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