Stock Options Question

...Today I am going to feature a question I received from a member and how I answered this question. As you know, I answer questions all day long for members of this site.

E-mail Question:
Hello Chris,
I hope the Holiday was enjoyed by you and yours. I see MCO on the daily screen and am curious about long term options. As you know, I have AAPL options (both Jan 55 and April 55 calls) that move pretty much in unison with each other. Sometimes the April call actually goes up more than the January during the day. Actually I just missed selling the Jan. options at the top today and am watching them closely (60% profit). Anyway, how much does an option move that is a year out? I've learned my lesson and with options, I will NEVER hope that they will come back and let the loss get bigger than it should be which depends on how many contracts I have. 10 contracts and I can let it go down quite a bit (never more than 50%) but the 30 to 60 contracts that I've held at one time in APPL, not even close to that much of a loss! That's why I asked about the signs of a correction coming but that's for another day.

If you were to buy the long term call for MCO, how high would it have to run before the profit started building up? I'm thinking that far out, it wouldn't move much for the first part of a run.
Bob

My Answer:
Bob,
I am going to use one example to explain this:
Say I buy the Jan 07 $55 call for $10.60 per contract (the asking quote this morning - 11/29/05, 9am).

This means that your break even point will be $65.60 (anywhere during the contract period minus fees and taxes). The break even point is always the call target ($55) plus the premium that you paid ($10.60 in this case).

If the stock moves to $80 in the next two months, the premium will be worth approximately $25 so you would have a profit of 150%. You would have this same profit if it took until next December to move to $80. For every dollar that the stock increases above $65.60, you can add a dollar to the premium you paid. I know time factors and volatility play a role in the actual premium price and the spread between the bid and the ask but the dollar approximation is a simple calculation that can give you a general idea of your potential profits at any time.

If the stock takes 8 months to move to $100, your call premium would be priced near $45 each (a $35 profit per contract or 350% profit). Remember, the breakeven is $65.60 so take $100-$65.60=$34.40 profit; add the original premium that you paid ($10.60) and you get the approximate price of the option contract at $100 = $45 ($34.40+$10.60).

You can have an immediate profit in a long term option if the stock price rises quickly above the breakeven area.


Although I do not teach options on this site, I am open to questions privately and will let you know if I am qualified to answer the question when it relates to options.
Thanks and Enjoy,
Piranha