Frequently Asked Questions on Options
What is my potential loss if I sell a naked call option?
Losses on naked option shorts are said to be “unlimited”, which definitely sounds like a lot! However, in reality the losses will actually be the strike price of the sold option less the current stock price. As the stock continues to trade higher, your losses will continue to grow. As there is no upper price limit on a stock, most refer to the losses as “unlimited”.
If shares are trading at $50 and the $60 call is worth 0.50, what is its’ value?
Technically, the value is 0.50 as this is the market price of the option. However, you need to keep in mind that there are two components to an option price; intrinsic and extrinsic value. The intrinsic value is the value of the option if it were to be exercised immediately i.e. only ITM options have intrinsic value.
Extrinsic value, which is also called Time Value, is the component of the option price that is not intrinsic. OTM options are made up entirely of extrinsic value (time value).
In this sense, this option has 0.50 of time value and no intrinsic value. If the option were exercised immediately, it would be worthless.
What is Delta?
Option delta is a calculation that tells you how much the option price will change as the stock moves one point. The value is represented from 0 to 1 where 0 the option is worthless and 1 the option moves point for point with the movement in the stock.
ATM options have deltas of 0.50. That means that if the stock moves up OR down by 1 full point then the value of the option will move up or down by 0.50.
Delta also approximates the percentage that the option will expire in-the-money. An ATM option therefore has a 50% chance of being worthless by the expiration date.
What happens to an option after a stock pays a dividend?
Nothing! By the time a stock comes to actually pay the dividend, the value change to the stock has already occurred.
The important date when it comes to dividends is called the “ex-date”. First, a company declares that they will pay a dividend and on what date the dividend will be paid.
At the same time the company will also announce the ex-date. The ex-date means that any investor that buys the shares after this date will not be entitled to the dividend come dividend date.
So, after the stock passes it’s ex-date, the stock price drops by the amount of the dividend that the company will pay.