Weekly Option Trader

About fifteen years ago, my first stock broker told me a story that happened to him almost twenty five years earlier.  I can’t remember all the details, so it can’t be verified.  He swore it was true, and if you can’t trust your stock broker who can you trust?

To make this point, I’d like to share the story the best I can remember.  It takes place when my broker started in business, in the early 1960’s.  He had some clients wanting to buy stock in a company he had never traded before, but the name was familiar.  In doing research about the company, he discovered a new company had bought the “corporate shell” of an older, out of business company.  (It is a long and difficult process to turn a company into a publicly traded company.  Many times it is easier to merge into the “shell” of an abandoned company, and fill it with your own “slug.”)

This “new” stock hadn’t traded for years, maybe even decades, but now had volume and an increasing price.  Why was this company familiar?

My broker told of being at his childhood home and realizing the reason for the stock’s familiarity.  He remembered, his parents had lost a fair amount of money in the “old” company years earlier.  All that was left of the monumental loss was the reminder his father had framed and hung on the wall… the stock certificate.

The story goes, he took the certificate off the wall, sold it to his client.  Giving his widowed mother the money and earning a large commission from his satisfied client.  If I remember the story correctly, the new company went the way of the old, it once more became a shell.

The moral of the story; If you own a stock long enough it may come back from the dead.

With an option, there is no after life, no reincarnation!  One funeral is all it gets.  If your option dies, you don’t get a certificate to hang on your wall.  All you have left is the trade confirmation from your broker and the memory of the money in your account.

Options are a fixed time investment.  After expiration, they cease to exist.  When buying options, you need to be right, and right on time.  Stock prices go up, they go down and they stay the same, but time always passes.

The nice thing about time, it’s consistent.  Time’s passage is an integral part of an option’s price.

Time Value and Time Decay:

Option prices can have two elements, Intrinsic value and Time value.  Intrinsic value is equity, a “down payment on the stock.”  Time value is potential.

If an option has time remaining, the stock has the capability to move.  Consider time value as possible movement value.  At expiration, there is no time, there is no potential.  The “Greek” term Theta measures the time value decay of an option.

The Laws of option pricing are constant.  The Laws regarding time value include; “The At the Money Option ALWAYS has the highest time value.”  “Time value drops the further In or Out of the Money the option moves.”  “Time value decays at its square root.”