Can you profit on the decreasing time value of call options?

Question

Given that call options have time value added into their price and that time value decreases as the expiration date nears. Can someone make money by selling calls and buying back their calls as the time value decreases?

If so how does the stock price affect the call value as you begin to look at buying back you calls to close? How does the price you have to pay to buy your calls back to close reflect the price change of the stock.

Use the example: Stock X trading at $5 whose call option with a strike of $3.50 costs $1.60 per share with a full month to expire. Thanks

Answer 1

The premium of any option is made up of intrinsic value and time value. The intrinsic value is how much the stike price of your call contract is in the money. Time value goes away each day you get closer to experation date. You can't make money on decreasing time value unless the intrinsic value is going up, to do that your contract has to be going more and more into the money. So using your example, a $5 stock that you buy a call on, with a $3.50 stike is in the money $1.50., if you paid a premium of $1.60 you will not make money until the value of the stock goes up. The higher and the quicker it goes up the more money you will make. If the stock price doesn't move or goes down, you will lose money every day as time value disappears and you move more and more out of the money.

If the stock jumped tommorrow to $10.50,than you could close the contract at a nice gain. You would be $7.00 in the money and have some time value as well.

Good luck.

Answer 2

I am not 100% clear on what you are asking but I will try to answer what I think you are asking.

I am going to assume you mean writing calls against shares you hold in your account (covered-calls). Selling them with a month till expiration (1 month extrinsic value) and buying them back to close your position at a cheaper cost leaving you with the difference of the sale as a profit. Yes you can do that but you run the same risk as everyone else who does that and that is that your shares are called away.

As an option approaches its expiration date the extrinsic/time value starts to decrease more and more rapidly as it gets closer to the date. The theta (change in an option's premium with the underlying asset remaning the same) will lose more time value daily with 1 week left as opposed to three weeks left. So with a few days or weeks left the call option HOLDER would need the underlying stock to catapult to make up for his/her loss of time value on the option(which is good news if your the writer/seller of the call)

Stock X is trading at $5 whose $3.50 calls costs $1.60 ($1.60 x 100 shares/contract=$160) with one month till expiration. First, if you sell to open a call that is $1.50 in-the-money it will more likely than not be called away and you will need to deliver the underlying shares. Second, you would want the shares of the underlying to plummet, so just to use easy numbers the share price drops to $3.25 and let's say that the calls now cost .55 cents with 3 weeks left till expiration. Now not only are you temporarily insulated from an exercise but you also can close your position that you sold for $160 at a market price of $55 for a $105 profit.

Sell covered calls when you anticipate an imminent decline in the shares of the underlying stock. Hope this helps

Answer 3

<< Can someone make money by selling calls and buying back their calls as the time value decreases?>>

You can. But you will only make money if Stock price stays at where it is or goes low (i.e. a stable market or a bear market). You have an unlimited loss potential if the stock price goes up.

<<If so how does the stock price affect the call value as you begin to look at buying back you calls to close? How does the price you have to pay to buy your calls back to close reflect the price change of the stock. >>

If the stock goes down you make money, as the call option you sold falls in value. If stock stays where it is, call option still loses value as it loses time value (which is what your original question is). if stock goes up, you will start losing money.

<<Use the example: Stock X trading at $5 whose call option with a strike of $3.50 costs $1.60 per share with a full month to expire. >>

You are selling an ITM call, getting $1.60.

a) Say, after a month, stock stays at $5. You will have to buy the call at $1.50 on expiration date, so you make a profit of $.10 cents theoratically. (It will be less than that, as there will be commission costs etc).

b) If stock goes down to $4, you will have to buy the call at $.50. So you make a profit of $1.10. If stock goes below the strike price of $3.50, you get to keep the whole $1.60 you got as premium.

c) if stock goes above $5, say $6. You will have to buy the call at $2.50. So, you have a loss of $.90. As the stock keeps going up, your losses keep going up. So there is an unlimited loss potential.

      A safer strategies to benefit from time value are Calendar spreads. You sell a call from a closer expiration date and buy a call from a further month expiration date. On the closer expiration date, time value of the call you sold will be zero. Where as time value of the call you bought will have some value. So, you benefit from the differential in time value. Your returns will be conservative, but you dont have unlimited loss potential as was the case in your original problem.

To understand the various scenarios in Call Calendar spreads, take a look at: http://www.optionwin.com/Members/callcre... .

You get to see Max loss, Max Profit, you can experiment with charting to see the effect Stock price change etc.

The blog page http://www.optionwin.com/Home/Blogs/tabi... has a nice write up on when to use Calendar spreads.

Answer 4

You sure can.  Time value is referred to in options as the greek letter theta.  If you buy options, you have negative theta, which means that every day goes by, you lose money from time.  Many options with strike prices near money have very high relative thetas.  For example, I was just looking at a call on T that was losing $3 per day from time.  It was about $70, so this is several percent per day.

The problem is: the majority of the options' value is determined by price.  The options relationship to price is called delta, and may be $50 for an at-the-money option.  So: you may sell that call on declining time for $70, get your time value so you could buy it back for $67, and then have the stock go up so you would have to buy it for $117, a huge loss (the delta is a bit smaller than that for this particular option I believe, but it is just an example).

At best, selling these options to capitalize on time will help you yield a few extra percent than outright buying options, but you should be aware of all the risks and details before doing it.  In most cases, this edge will be small enough only to cover the spread and commissions at best, unless you take on additional risks  Read the options tutorials on this site below, and you may also like to read the books "Getting STarted in Options" and "Options as a Strategic Investment" if you are serious.

http://investopedia.com/university/

Good luck.