Im new to options trading and I had a question about day trading options. I’ve been playing the earnings game (I’ve done well I hope). However, my question is : I sell an option a week before expiration date for a huge profit 2-300% however the strike price has not been met. How does this happen? Example for today I purchased a $40 call on MLHR last night with an expiration of 7/20. I sold it today on 7/3 when the stock was at $38 for a 120% gain. How does this happen, and why would anyone wait to excersise at $40/share when you could sell the contract for much more profit? Am I selling the contract to someone else at a higher premium? And again before the strike price so what is the point of it? Thank you in advance
Well in this instance, MLHR went up to $39.50 last night (and even opened up at $40.10), which is very close to the strike price and with 2 weeks left to go before expiry there is a good chance it could make it over $40. In general stocks with very high volatility can command high premiums, i.e. you could sell for a profit before it even hit the strike price. MLHR today has a pretty high volatility (but it ain't no IQ y'know).
What @anotherdevilsadvocate states is true. Stock with high IVs -- implied volatility -- command higher premiums over their HV -- historical volatility. With the $VIX at 16, option pricing get more expensive. Generally speaking, a 16 $VIX implies over a 150 point move in the DOW each trading day (up or down). This is fundamental to grasp for it skews the cost (of options) across the bell curve which ends up affecting your cost basis in the trade. Time is also a factor. Since you bought the July option, your option is privy to bigger percentage swings since those options expire in two weeks time. A 5% move, in a matter of days can translate into moves multiples over the move of the underlying security, especially if those are OTM -- out of the money -- options. Why? Because the options market assigned a lower probability on those options based on the IV (probability that MLHR closes at or above $40 + plus the cost of the option). Not only were you rewarded for getting calling the direction of the stock, but part of the return you made is partly represented in the shift in pendulum in the probabilities of the option. Whereas a week ago the options market was pricing in, say, a 20% probability MLR closed above $40 by July expiration, its now closer to 85%. That difference in probabilities is reflected in price, and in the end, in the return you made. Had you taken a more conservative posture and bought an ITM -- in the money -- call, say the $35 call, your call would have appreciated but not by as much since the market had already assigned a higher probability to the trade. To answer the second part of your question; someone may want to exercise those calls at $40 if its part of a bigger trade. Maybe someone who bought MLHR at $45 may want to reduce his cost basis in the stock. Getting assigned at $40 + the cost of the option is a practical way of doing so. It could also be that the individual is looking to amass a bigger position in the stock over time and is in the process of writing (selling) calls in the future against his position as he waits for a confirmatory move on way or another. There are other factors at play but these are the main reasons why you saw those options move the way they did. Be thankful you saw those type of returns. The market rarely awards those gains. Believe me.
