Time Value and Out-of-the-Money Options

Returning readers will be familiar with our continued negative outlooks for many of the market’s problem children – financials, REITs, and certain commodities. A short while ago, we posted about an aggressive series of trades on that thesis, and promised to track the progress of both the underlying positions as well as a specific options play on each.

To recap, the positions are:

  • Long UltraShort Real Estate (SRS)
  • Long UltraShort Financials (SKF)
  • Long CBOE S&P Volatility (VIX)*
  • Short United States Oil (USO)

*You cannot directly “buy” the VIX

The returns on the first day were very good – on average, +4.78%. The options positions – a simple combination of long out-of-the-money calls and puts – performed even better. The contracts are:

  • UltraShort Real Estate $57 Call (SRSBE)
  • UltraShort Financials $140 Call (SKFBJ)
  • VIX $42.50 Call (VIXBV)
  • USO $29 Put (UBONC)

The average position returned +25.365% on the first day the trade was put on, but as is often the case in a choppy market, these positions were bounced around and lost value before today’s sell-off brought these positions strongly back to the green.

The listing below shows the closing prices of the underlying positions as of the last update, the closing price on February 10th, and the performance between the two dates.

Jan. 30 Close Price, Feb. 10 Close Price, % Change

  • SRS: $59.32, $62.60, +5.53%
  • SKF: $143.26, $145.53, +1.58%
  • VIX*: 44.84, 46.67, +4.08%
  • (Short) USO: $29.22, $26.91, -7.91%

Average change in the underlying positions since the Jan. 30 close: +4.78%.

Cumulatively, this gives an average change for the underlying of +10.71%.

As for the options:

Jan. 30 Close Price, Feb. 10 Close Price, % Change

  • SRSBE: $9.70, $8.60, -11.34%
  • SKFBJ: $23.30, $17.80, -23.60%
  • VIXBV: $6.00, $4.90, -18.33%
  • UBONC: $2.00, $2.65, +32.5%

Average change in the options position since the Jan. 30 close: -5.19%.

Cumulatively, this gives an average change for the options positions of +17.79%.

For comparison purposes, since the market open on January 30th, the S&P 500 has returned -2.20%, and the bets used here to take advantage of that outlook have paid off handsomely. Overall, this is a solid performance, but there are always lessons to be learned.

Here, it’s important to note how time decay affected the value of our options positions. The underlying positions all moved in our favor during the last week and a half, but the options positions (while still up nicely) have declined in value from their original highs. Below is TradeKing’s Options Calculator, which shows the Greeks for each of the options – notice the consistent erosion in option value due to theta, or the sensitivity of an option’s price to one less day to expiration. See here for more on the Greeks.

Again, purchasing out-of-the-money options is a simple way to express a long or short view on a particular stock, industry, or index (including broad market indices and volatility). Although this can be a surprisingly tough way to make money, with the proper trading discipline and timing, the rewards can be large.