I got a question from a long-time reader–Wilson M.–today, that I thought was a good one. I’m sure a lot of people have wondered the same thing, so I asked Wilson if it would be okay to post our conversation on the IOI Blog. He graciously assented, so here it is. Hope this exchange helps you as well:
- Option liquidity and bid-ask spread. If the spread is too large, I usually just assume I?ll have to own the stock eventually, so do a lot of valuation work up front. Doing that, I feel more confident about keeping the thing open until expiration and don?t mind owning the underlying.
- Perceived probability for negative news. For liquid options, I don?t mind trading out ahead of time if I start to see more signs that there could be something negative to valuation on the horizon. I did this with Western Union WU a few years ago, because I started to get worried that the Morningstar analyst was not being realistic in his assumptions for the possibility of a slow-down in European and North American migrant worker populations (one key driver to WU?s business model).
- Unrealized profit. If I find that I am worrying about negative new on a stock in which I have a position in a liquid option, and on which, if the option expires OTM, I?ll only make an additional $0.05 or something on premium of $1.75, for example, my fear usually overwhelms my greed and I?ll leave the extra $0.05 on the table and close out.
|Western Union Stock Price
Source: Yahoo! Finance