Ken Trester

The Thrill of Expiring Options

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The close-to-the money call (that is, the option with the strike price closest to the market value of the shares) was moving back-and-forth between a high of $1, all the way down to 12.5 cents, with just two days left before the calls expired.

Seeing this, I decided to enter an order to purchase the call at 12.5 cents, and the order was filled during the day, whereupon I established an order to sell the option at $1. Given the volatility of the trading, with those 85-cent-plus swings, there was a decent chance that this "long shot" could be achieved.

My order was filled a few hours later, giving me a 700% gain.

Had I not entered the sell order, I would have lost my original investment, as the option ended up expiring worthless. Fast action is needed with this strategy, so if you know you'll have the time to monitor your trading account when expiration approaches, this is a great play. But remember, you should only use your "Vegas money" -- that is, money you can afford to lose, because often expiration plays are an all-or-nothing wager.

During the life of an option, its price is based on a variety of factors, including the underlying instrument's price as well as something called time value. Essentially, time value means that the farther away an option is from expiration, the more time it has to move into profitability and, thus, the more likely it is to become a winner.

As expiration closes in, option values decay much quicker. The deeper in-the-money the option is, the better the chances it will finish profitably. Buying expiring options that are at-the-money is more of a risk because an unpredictable day in the markets may mean that the option jumps in your favor or bolts in the opposite direction. The good news is that if you can get in on a dramatic dip, as I did in the IBM example, it would have only cost $12.50 per contract. And for the potential gain of more than $85 per contract, the payoff justified the risk.

What a Difference a Few Days Can Make

Can't decide which equity options to invest in as the witching hour approaches? Then take advantage of the volatility in the overall markets by establishing plays on the broader indices.