That’s because time premiums tend to be very high during panicky day. Why waste money buying time value on a day that time value is expensive? If you like you can switch that to calls some later day when the market is calmer and the stock price is higher, saving a whole lot of money on time value.
While time value is higher on a panicky day (which most bottom days typically are) than a calm day, wouldn’t intrinsic value (and thus the premium) be higher on a calm day since a calm day would typically occur days/weeks after a bottom and after the stock price has risen significantly?
With intrinsic value being a much larger chunk of the total premium than time value in DITM calls, I would have thought that the higher intrinsic value on a calm day would totally offset the premium savings due to reduced time value (and then some), making the panicky day better to buy calls.
Is your experience the opposite or am I missing something? Signed, options newbie.
While time value is higher on a panicky day (which most bottom days typically are) than a calm day, wouldn’t intrinsic value (and thus the premium) be higher on a calm day since a calm day would typically occur days/weeks after a bottom and after the stock price has risen significantly? …Is your experience the opposite or am I missing something?
For a deep in the money call, at any given strike, the higher the stock price the lower the time premium.
They are deeper in the money when the stock price rises further up and away from the strike price.
The time value of a $200 call is higher when the stock price is $240 than it is when the stock price is $280.
If you were simply buying to go long, sure, you’d want to buy it at a moment of the lowest possible price, which is with a high/expensive time value.
You want to enter any new long position at the lowest tick, if possible.
But if you’re merely transforming an existing position–switching from stock to calls, or rolling existing calls out to a later date–
you want to do that when the stock price is as high as possible and the market as calm as possible.
That is because you’re a net buyer of time value during such a “transformation”, so you want that time value for the specific thing you’re buying to be minimized.
Is that clearer?
So, my suggestion was:
Stock price low? add to your long exposure with plain stock, as it’s the cheap way to get long exposure.
Lowest breakeven. Though it ties up the most cash.
Stock price high? If you want to free up some cash, switch from stock to calls, or from low-strike calls to higher-strike calls.
Also a good time to switch to a later expiry date.
Add long exposure when low, but “transform” when high.
Stock price high? If you want to free up some cash, switch from stock to calls, or from low-strike calls to higher-strike calls.
There must be some subtlety involved here because this is exactly the opposite of how I do it.
You’re saying to employ leverage (or more leverage) when the stock price is high?
Certainly if you want to raise cash for groceries without reducing the number of shares you control, then more leverage is the cost of doing that. But I know you have advocated many times for employing leverage when the stock is cheap.
You’re saying to employ leverage (or more leverage) when the stock price is high?
Think of it as two separate things.
Increase stock exposure when the stock price is low, obviously.
You can do this with any instrument you like, but the ones with low leverage give the best entry points.
This ties up a lot of cash.
Then, optionally, later, when the stock price is high:
Increase leverage without changing your stock exposure.
(roll up, or roll up and out, or switch from stock to calls).
This frees up a lot of the cash you tied up during the dip.
This combo gives the best overall performance. You buy expensive high-breakeven securities only when they are cheap.
But of course it requires you to have enough cash on hand to load up without high leverage when the stock price is low.
If you don’t have that much cash, you can’t do this…you’re forced to use high leverage securities to add during a big dip.
Interestingly, you can do this forever, never changing the number of shares you control,
just freeing up some cash profits from time to time when you roll up (and out).
Strike prices that used to be high leverage aggressive ones eventually become low, conservative ones.
The cash is raised very irregularly–you might only free up cash once every 3-4 years, even 5.
But still, not a bad deal. Also not a bad description of how I make a living.
Just a reminder to everyone that leverage is a bad idea.
This is one of those threads which does not fall into the prudent investing category.
I’m not prudent.
But if you’re merely transforming an existing position–switching from stock to calls, or rolling existing calls out to a later date–
Ahh, this helped it all click for me.
If a person already has an existing stock position they’re converting to calls, then waiting for a calm day (after the market has risen) to buy the call doesn’t hurt you much since you’re already benefiting from the stock price rise via your existing position.
So even though the call premium has risen due to higher intrinsic value, you’ve benefited from that on your existing stock position so it’s really a wash (nothing lost).
So all that comes into play in that situation is the time value premium which you benefit from by waiting for a calm day.
Stock exposure is like hamburgers.
You want to buy more when it’s cheap. Low stock price.
But the time value in options is ALSO like hamburgers.
It’s nicer to be a buyer of time value when THAT is cheap…which is when there’s a high stock price!
Conveniently, you can split those purchases into different dates.
I bought some stock today. I didn’t buy time value, because time value is expensive today.
I’ll probably sell that and switch to calls next time the stock hits new highs.
Just a reminder to everyone that leverage is a bad idea. This is one of those threads which does not fall into the prudent investing category. I’m not prudent.
Jim
I have always disagreed with Jim on the…efficiency of the above strategy, but I want to give him huge kudos for being 100% honest about the risks of such, even for professional traders:
Leverage doesn’t add value or destroy value, it only magnifies the result or if you are wrong, you are going to be wrong bigger or if you are right you are going to be right lot.
A little leverage to juice results should not push people to bankruptcy, it is unmitigated risk taking, and fundamentally wrong bet, when coupled with concentrated bets.
Most individual investors are not Buffet. So don’t concentrate too much, rather diversify.