By knowing what does in the money mean, we can find out why did we make more on the futures contract than we would have by just buying a call? The reason is that until an option gets deep in the money, it will not increase in value as quickly as a futures contract. It has to do with the Delta of the option. Delta is calculated by how close the strike price is to the futures price. No need to get into it now but rest assured that we will look at it in detail before you finish the course.
It’s very important that you understand that an option will not increase in value, even if it’s at-the-money or in-the-money (until it’s deep in the money), at the same rate a futures contract does.
So don’t expect that when you buy an option that is out-of-the-money that if it gets in-the-money that it will increase in value at the same rate it would if it was a futures contract. It’s just not going to happen.
You need to keep this in mind in both buying and selling options. As we go through the course, you will see many examples of this. Let’s look at Figure 2.12 through 2.15 to see what I mean.
We were filled on both the futures contract and the Call Option (Figure 2.12). One week later the futures contract increased $3,140 in value and the Call Option is worth $3,930 an increase of only $1,430 (Remember we paid $2,560 for it) which is about ½ of what futures increased. Figure 2.13
See Figure 2.14 - The last change on the futures contract was an increase of $7,130 (A) so the total profits on the futures contract is $10,150.(B)
Now look at the option we bought and you can see that it’s $5,000 In-the-money “C”. The value of the option is currently $8,110 but since we paid $2,560 for it, the profit on the option is only $5,550.
The futures contract made almost twice what the option did and if the price continued to climb then eventually the option would go up at the same rate, dollar for dollar, that the futures price goes up. But it has to be Deep In-the-money for that to happen.
Let’s look at a couple more charts because it’s so important that you understand this I want to make sure you have several examples.
In figure 2.15 I want to show you that if we bought an At-The-Money Put at 235.00 for $587.50 and also went short the market with a futures contract from the same price, 235.00 how the Put and the futures contract go up in value as the price of the futures market goes down.
You can see in figure 2.16 that we were filled on both the futures side and the Put side. It’s going to be interesting to watch and see how long, if ever, it will be until the Put is making dollar for dollar what the short futures contract is making.
Looking a couple of months into the future (figure 2.16) and the Put has made a profit of $737.50 but the futures has made us $1,387.50, almost 100% more than the Put made but the interesting thing is the strike price and the price we entered the market were the same, 235.00 on the same day.
It takes getting really deep into the money for an option to go up in value, dollar for dollar, that a futures contract does.
And Options are much less liquid than futures contracts so you can have more slippage than you can with a futures contract. Slippage? How can that be? If an option is worth $500 are you telling me that I can’t buy it for $500? Yep, not always anyway. Now before you get bent out of shape, I want you to put your thinking cap on for a minute. How can this be a positive thing that I might not get what my option is worth if I try and sell it? Think! Did you figure it out yet? Of course you did and it works to your advantage when you want to buy an option. Just because it’s worth $500 doesn’t mean that you are going to have to pay $500 to get it! Try and make a bid to buy it for $450 and see if you get a “bite”. You never will know unless you try.
In the options market, you can make offers to buy or to sell at a specific amount. It’s like putting an offer on the table and asking your broker to try and buy or sell it at this price. You can use limit orders to do this. Sometimes you will be pleasantly surprised at what you can find in the “bargain basement”.
Okay David, up until now, I was liking these options but it seems like the way to go is still with futures. Is that right? No, not at all. There are times to use options, there are times to use futures and there are times to use them together.
What options do, is give you more ways to control risk and more opportunities to trade. READ THAT AGAIN!
In the following chapters we are going to look at dozens of different option strategies that will have you “chomping at the bit” to get out there and start trading options. But you know what? Don’t do it until you have tested each and every strategy that I’m going to show you and that you are extremely comfortable with what you are doing. Paper trade all these for 30-60-90 days and know how, and why, they work and what happens if they don’t work. And remember nothing works 100% of the time.
When I was learning to trade I took no one at face value after getting “stung” with my first Guru. I didn’t care who they were, what they had written, how much money they said they had made or anything else. I had to prove to myself that what they were telling me did in fact have merit. I suggest that you do the same thing with this course. Don’t just take my word for it, prove it to yourself. Then and only then, can you start to feel comfortable that you can make money using these concepts. Once you know what does in the money mean, then you will truly be in the money and on your way to success with option trading.
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* Testimonials are not a guarantee of future success. All information is for educational use only and is not investment advice. Trading financial instruments, including Stocks, Futures, Forex or Options on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in any of these financial instruments you should carefully consider your investment objectives, level of experience, and risk appetite. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. The possibility exists that you could sustain losses exceeding your initial investment. You should be aware of all the risks associated with trading and seek advice from an independent financial adviser if you have any doubts. Past performance, whether actual or hypothetical, is not necessarily indicative of future results. All depictions of trades whether by video or image are for illustrative purposes only and not a recommendation to buy or sell any particular financial instrument and do not factor in trading costs in trading examples due to varying commission and fees among traders. The impact on market prices due to seasonal, market cycles or news events may already be reflected in the price. See full risk disclosure. See full risk disclosure.