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21

Interesting. Not just out of the money, but fairly short term too (less than 6 months). I’m partial to the January '24 $300 calls.

The higher ones are certainly cheaper to buy, but the breakeven is pretty high.
So it depends if you think of them as a quick trade in their own right, or a way to add to the size of your position.
If the latter, the breakeven entry price is what matters in the long run.

My little 280 position is doing nicely today…up 37%. Time value rising, even though they’re still out of the money.
With today’s high so far of $279.66, a strike of $280 looks like it might go into the money a bit sooner than I expected.
As you note, it’s fairly short term contract, but seemingly long enough to reach the “in the money” stage.

More geek notes:
For my suggestion of rolling them down, incidentally, the math on this is interesting.
If you own a call option now at the money, and want to roll it down to improve your breakeven and lock in a profit on the time value,
the two interesting numbers are how much you improve your net entry price, and how much extra cash you tie up by doing so.
If you divide the two (and annualize it) you can see your rate of return on extra cash tied up.
This can be a shockingly high number, even if you only roll down a small amount to a slightly lower strike.
40%/year rates are not uncommon, depending on the time to expiry.
There is a bit of trade-off in terms of the rate of return and the absolute magnitude of the benefit.
Roll down more, tie up more cash, bigger absolute improvement but lower rate of return on extra cash committed.

The other alternative is just to let it ride.
Roll it shortly to a later date before expiry.
After all, it didn’t cost much.

Jim

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22

Would you indulge this options newbie with some greater specifics…

It doesn’t track it 1:1 like that, and the pricing seems to be much more sensitive to market feelings: if the stock has trended downward, the options take a large hit, if the stock has trended upward the options get overpriced.

You’re buying the right (but not the obligation) to purchase 100 shares of BRK.B for $300 per share between now and January 2023. At the price you quoted, this would cost you $1,090.00 +trading fees.

I don’t try and make guesses as to how much the option will trade for, other than basing it on the underlying stock. So I calculate a reasonably-likely price for Berkshire at expiration. If that’s $322 for you come this January, your calculation would look like this:
($322 - 300)/10.9 = 2. And you’d be doubling your money.

But there’s a chance BRK.B doesn’t get above $310, in which case you might have a loss.

It’s way, way more prudent to pick up something like a $140 call (even then you’re essentially borrowing half the stock value!). Than it is to buy a call that’s higher than the current trading price (we call this out of them money).

I have a little spreadsheet where I copy all of Yahoo’s options for the expiration I’m looking at, right now it’s January 2024. I have values for what BRK.B might trade at expiration (or before). The first assumes they’ll be able to grow book value by 20% per year in the remaining 1.5 years, and the stock will trade for 1.25x book value. So 230.31 x 1.2 x 1.1 x 1.25 = $380. My second value sort of follows favorite poster of mine, but forgets we only have 1.5, not two years (whooops), and looks like this: $268.08 x 1.182 x 1.182 = $374.54.

When you set up a spreadsheet like this, you’ll see the higher options returns are negative. Because you don’t have the obligation to purchase the shares (only the right, remember?) you won’t lose more than your initial money, but that’s probably little consolation as you’ll lose all your initial money. My spreadsheet right now is showing options above $380 would have you lose all your money.

$310 and $320 options have almost a 3x multiplier on my spreadsheet, but they have a higher probability of loss too so I’m staying away.

23

With today’s high so far of $279.66, a strike of $280 looks like it might go into the money a bit sooner than I expected.
For my suggestion of rolling them down, incidentally, the math on this is interesting.
If you own a call option now at the money, and want to roll it down to improve your breakeven and lock in a profit on the time value,
the two interesting numbers are how much you improve your net entry price, and how much extra cash you tie up by doing so.
If you divide the two (and annualize it) you can see your rate of return on extra cash tied up.
This can be a shockingly high number, even if you only roll down a small amount to a slightly lower strike.
40%/year rates are not uncommon, depending on the time to expiry.

PS, a worked example:

Well, the stock price cracked my $280 strike price today, so my out-of-the-money calls are now slightly in-the-money.
So, as planned and discussed, I just rolled them down to a lower strike to lock in the profit on the time value.
Again, this is a fun money position, so I didn’t obsess about the optimal destination position, I just picked something.
I sold the January $280s for a 53.0% profit since Thursday, not annualized. The stock was up 6.1% in the same stretch.
Bought at $15.01, sold at $22.97.

Then I immediately bought January $230s instead. (Not a sensible pick, implied interest rate for the borrow is 7.43%/yr rate, ouch)
Anyway, rolling down from $280 calls to $230 calls improved my breakeven by $12.98 per share.
(I realized lots of time value for at-the-money options I sold, and paid comparatively little time value for in-the-money options I bought).

These lower strike options tie up more cash, of course: $37.02 per share more.
So my return because of improved breakeven on the additional cash tied up for the next 207 days is 12.98/37.02 = 35.1%.
Annualized linearly (no compounding) that’s a rate of 61.9%/year. And it’s a sure thing.
Today’s trades were worth the bother.

I would of course still have a much better entry price on this position if I’d simply bought stock last Thursday!
Don’t think any of this is what you’d call “sensible”. This isn’t a recommendation, more of an example of a quirk of option pricing I had mentioned.
So why did I do it?
My cash tied up to date is trivial: $15 per share for four days, and $52/share till next January unless I take profits before then.
My “fun money” account didn’t have oceans of cash in it and I aim for the moon more, so the leverage was a fit.
And it has indeed been fun so far.

Jim

8 Likes
24

Fwiw, I’m back in with the fun money again on the OTMs. I’m not even a big Star Wars fan but somehow the Sith Lords got me. Cheaper than flying to Vegas right now anyway.

Jeff