A question regarding projected value of an option contract when a stock hits the Target If we purchase the option when the Alert is issued, can we project the option value by multiplying the dollar move by the delta and adding that total to the original option price? (August 17, 2002)
We love using options for several reasons, but some key points are the leverage it gives us to enter positions on higher priced stocks without putting up the farm as well as a clearly defined risk. Those can provide tremendous returns. You also need to understand your targets well because options are time and price sensitive. We take you through a very straightforward and direct approach in our Options You Can Use Seminar. It takes the mystery out of options and shows you how to use these powerful tools in your investment arsenal.
As for calculating projected option price targets, the procedure you outline is how we figure out where to put in a sell order on option plays, and we use a variation to always calculate our potential percentage gain on any position to determine whether it is worth the money we have to put into the play.
We figure out what the dollar move the option will make, multiply that by the delta, and add the result to the bid price of the option at the time we bought it. That gives us roughly the bid price of the option (the price we can sell it at) when the stock hits the projected target. We use the following formula to pre-enter sell points for option plays or for buy back points in covered call plays (except we use the option ask price as opposed to the bid).
The formula: (Stock buy price - Stock target price) x option delta + option bid price = option bid price when stock hits target price.
It is also important to determine the percentage gain on an option play to see if it is worth our effort for the return. This is particularly true when playing puts or calls with definite support or resistance levels we anticipate will stall the move. We want to have enough of a return that is not eaten up by the spread and commissions.
The formula: (Stock buy price - Stock target price) x option delta/option ask price
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