Options theory says: If volatility remains the same, then time
premium (i.e. the difference between option price and how
much the option is in the money, or intrinsic value.) decreases
as the square root of time remaining to expiration. This ignores
interest rates, which is okay for short term stuff with high volatility, I
think.
So the rule for estimating your a future option price: Take the square
root of the ratio of time remaining to expiration to the time remaining
at the time you expect to sell. For instance, if there are 45 days
remaining now, and you expect to sell in 30 days, their will be 15
days remaining then, and the square root of the ratio will be sqrt(3).
Now, look up the bid price on the option corresponding to the one
with the same relation to the underlying security price after the
market move, as the one you are buying has to the current
underlying security price. In other words, if you buy the 360 put,
and the market is at 400, and you expect the market to go to 370,
look up the bid price of the 390 put. Take the time premium of that
put and scale it down by the square root ratio you figured out earlier.
The result should be the bid price of the put you are buying after the
market makes its move and the time has gone by. For these
heavily out of the money options, the time premium is the same as
the option price.
I couldn't get www.cboe.com to work yesterday, otherwise I would
work out the ratios/returns for a variety of cases.
What do you guys think the market will do on Monday open?
-- Carl |
