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Strategies & Market Trends : The Covered Calls for Dummies Thread
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To: FaultLine who wrote (1350)7/6/2001 7:10:33 PM
From: EnricoPalazzo   of 5205
 

[Stock has dropped, yet time premium of ITM calls has increased]

Frankly, this seems counter-intuitive to me as we now have less time to expiry than on Tuesday and the expectations for this call have declined since Tuesday. Clearly the mathematical predictions are correctly realized, but at a gut level I don't get it. Anyone interested in giving me a "common sense" explanation?*

It would indeed be surprising if the overall premium had increased, but the time premium is really a function of several different things. One of those things is the time to expiry--all things being equal, passage of time would reduce the time premium. But all things aren't equal.

Think of it this way. For an ITM call, the time premium is really the value of the right not to exercise (interest is also a factor). That's why a $5 July QCOM call probably has about no time premium. You could simulate your July 55 call without the right not to exercise by buying QCOM at $59.20, and borrowing $55. Ignoring interest, that would cost you $4.20 (you'd also need a pretty lax broker!). The only difference between that and the option is that if the stock ends up below $55, you don't have to exercise the option.

Given that, think of it this way: isn't the right not to exercise the call that's $4 ITM more valuable than the one that's $9 ITM? That overwhelms the minor difference in time to expiry (3 days).

Sorry if that's not common sense--I didn't learn much before I was 18 <gg>.

ardethan@lessonsincommonsensefromarmbsinvestor.ugh
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