In your newsletter and Alert Service you provide targets and stops for equity positions. Is there a way of converting them for use with options? I am not always able to hang around my PC for your alerts. (September 23, 2002)
Great question. There are two ways to look at options: the current option value and/or the option value versus the underlying security or index value. When we deal with our options we look at them two ways, a kind of blend of the option price and the underlying equity price.
First and foremost to us, particularly in the early stages of a play, is the underlying security. In the initial stages of a play the underlying security is the key. The option's movement is based almost entirely on the movement of the underlying security. Thus we are most concerned about that action as opposed to the value of the security. If the underlying is holding support or resistance, breaking out, etc., the option's value will track that performance. When time starts to ebb before expiration (and also if the underlying security slows down in its move or starts to stall), then the option value gets more attention. A security that is running and then stalls and loses momentum will start to see its option value fade a bit; if it is within 30 days of expiration, then time value starts to eat away at the value. At that point it becomes a function of time and movement: running out of time and the price is now stalling. Then it is more of a decision to take the gain because the stock has stalled and you are running out of time.
Thus, we use the underlying stock primarily to key our option plays. In almost all cases we decide to enter, exit, or stay in a play based on the movement of the underlying security. Only when time is running out will value overtake movement, and then only if the stock is not moving enough to offset time decay in the option. Now sometimes we will have a stock tank on us abruptly (e.g., a gap down) and leave us still in the options. If we cannot expect a reasonable chance at a recovery and the option hits a value of 50% of what we paid for it, we will close it out. The odds of it recovering from a 50% reduction in value is long. It can always happen, but over time you will save more money than you lose in that scenario.
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