Regarding option strike date selection. You are looking at PRX for a possible play and the pivot was hit but the volume was not there so the buy was not issued. Why select the Aug 30 call which is trading at 8.50-9.00 instead of the May 35 call which is 3.70-4.00. I do not understand the reason to purchase the call with that much intrinsic value or that far out in time.
You are correct in focusing on the right option to purchase as the price you pay versus the delta and and the time to expiration directly impact your return. You need to get enough movement to cover the spread (the bid versus ask spread is larger on options to take into account some of the time element) and make you money with plenty of time left before expiration. As you get closer to expiration, time value starts to eat the value of your option at a faster and faster pace. It starts about 60 days out, and then really accelarates when you hit 30 days to expiration.
In that respect we prefer slightly in the money options with a minimum of 2 full months to expiration for upside plays where we are looking for an explosive move higher. If the stock is a slow mover, 2 months is not really enough. Typically we prefer more time, balancing that with the cost to acquire more time and any decrease in the delta (the futher from expiration, the lower the delta, i.e., the amount the option price will move for each $1 move in the stock price). Over the years it is clear that we have done better with extra time simply because you don’t have to have down to the minute accuracy on entering the play. You hate to be right about the move but just not have enough time to take advantage of it.
As to the specific play, the August expiration is not bad though the May could work as PRX can move up rapidly and we were looking at roughly a 15% move as opposed to 20% or more. PRX can move $6 in short order; a ‘typical’ 2-week bounce up off the moving average in its uptrend returns that $6. As for the strike price, the $30 strike was a misprint. You are correct that we were looking for the $35 strike; with a buy point of roughly 37, the 35 strike put us just in the money with a sufficient delta (about 65) to make us a nice 65% or so gain ($6 move x .65 delta / $5.70 option cost = .68). Compare that with the August 30 strike: $6 move x .85 delta / $9.40 option cost = .54 or 54%. Even with the higher delta, the extra cost impacted your gain on the move.
Now there are benefits to a deeper in the money (higher intrinsic value) option. If the stock just sits there and does nothing, the option will lose time value. The $35 strike is just $2 in the money. The $30 strike is $7 in the money. At expiration, the $35 strike option is worth $2; you lose $3.70 or 65% of your investment. The $30 strike option at expiration is worth $7 (you could buy the stock for $30 and sell it at the $37 market price). In that instance you lose $2.40 or 25% of your investment. Thus buying more intrinsic value can benefit you if you don’t sell the option before it starts to lose value.. Now if the stock tanked, you are going to lose value on both though the deeper in the money option will hold more value and recover faster if the stock recovers.
