I really enjoy your comments and have learned a lot about the markets over the past few months. I would like to know if when you select options you give any thought to the option's intrinsic value and time value, i.e., do you want a certain percentage one way or the other? Thanks again for great advice. (September 12, 2000)
We never like to pay a lot for the portion of the option price that is out of the money. The cost of that portion is determined by a number of factors with time and volatility being the most important. That is one reason we prefer to buy options further in the money than most option traders; that is one way we pay less for the volatility and the time value.
Some traders prefer to search for the best option, i.e., the option that is 'fairly' priced as compared to the stock. That is fine if the stock is worth a darn or is poised to make a move. It doesn't do any good, however, to find some options that are 'priced right' but have a stock that is not set up to make a move. We would rather locate stocks that are primed to make a move and then select from the available options. Some times the choices are not just what we want, but the if the stock makes the move we want, that takes care of itself. The point is, we would rather have an option on a stock that is maybe not the best option available in terms of what we pay for the time and volatility than an option that meets certain parameters but is on a stock that is not going anywhere.
With that said, we do not apply any specific formula. We used to. At one point we wanted the non-intrinsic value to make up less than half of the overall price of the option. In August we were finding a lot of those as volatility decreased on the low volume move up. Today it is tougher as the volatility is rising a bit. What we found was we missed out on some plays that were technically very sound because the option pricing was not just right. If we get the play right and our entry point is decent, the option pricing usually takes care of itself. If the stock is very volatile and the option reflects that, we will be inclined to take profits after a run if the stock looks to be topping. That way we don't lose ground if the stock suddenly calms down and the volatility is sucked out of it.
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