Often I see options that are falling in price though the stock itself is actually rising in price .... I don't understand why? Can you help me? (April 19, 2000)
Option pricing is made up of many variables, one of the primary being time. Everything else being equal (for the sake of the example), an option expiring in three months has more time value associated with it than an option expiring next month. You pay for the time you buy. Moreover, that time starts to 'decay' the closer you get to expiration. Specifically, an option begins losing time value in the last sixty days, with the vast majority occurring in the last 30 days. For example, Thursday is the effective date for option expirations for April. On Monday we will be in the May expiration cycle. Regardless of what the May option closes at on Thursday, if the stock opens flat on Monday, the value of the option will most likely be lower. The reason? Because we have entered into that option's expiration month. As the expiration date nears, the time decay intensifies. To overcome this decay, a stock has to be moving. Movement, up or down, adds to the implied volatility, and that jacks up the option price. If the stock is moving up and you are looking at a call option, if the move is steep enough, the price increase plus the volatility increase will cause the option to rise. If the option is still far out of the money, however, the rise will be almost insignificant. The closer to being at the money or in the money, the rise will be greater.
Thus, you can have a situation where you own an April 100 call on JDSU. The stock is at 91.50. The stock can move up $8.50 tomorrow (expiration day), and still the option would barely move: as the stock moves up, the time is running out. If the stock gaps open $8.50 in the morning, you will get a little more for the option as you still have all day and the quick rise in price increases the volatility in addition to making the call at the money. If the move is slow and steady during the day, the option's value will continue to decline even as the stock rises, until it is basically zero at the end of the session.
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