| How Our Option Prices are DeterminedThe Blue Collar Investor
When we sell covered calls or cash-secured puts, we access option-chains to determine the value of the premiums we are selling. This article will highlight the factors that determine these prices and compare them to the prices generated by option pricing models like the Black-Scholes Pricing Model.
Factors that determine option pricing
- Consensus of all market participants (retail investors & professionals)
- Supply & demand (most important factor)
- Real value determined by what traders are willing to pay
- NBBO: National Best Bid and Offer: Regulation by the SEC that requires brokers to execute trades at the lowest “ask” price when buying securities and the highest “bid” price when selling securities
Option Pricing Models (Black-Scholes, binomial option pricing, and Monte-Carlo simulation etc.)
- Calculate theoretical option value
- Account for variables such as current market price, strike price, volatility, interest rate, and time to expiration
- The primary goal of option pricing theory is to calculate the probability that an option will be exercised or be in-the-money (ITM), at expiration
- Options pricing theory also derives various risk factors or sensitivities based on those inputs, which are known as the option’s Greeks
Real-life example with Intel Corp. (Nasdaq: INTC): Option-chain on 3/26/2024
- 3/26/2024: INTC trading at $42.09
- 3/26/2024: The 4/19/2024 OTM $43.00 call (pink cell) shows a bid-ask spread of $1.19 – $1.21 (yellow cells)
- Implied volatility is 35%, Delta is 0.4433 and Gamma is 0.1032 (brown cells)
- These stats are placed into an Option Calculator like the one provided by the Options Industry Council (OIC)
Options calculator entries (from option-chain)
Option Calculator results
- Delta and Gamma stats are similar to those on the option-chain
- The theoretical value of the option is $1.176, less than the $1.19 – $1.21bid-ask spread
- Based on this data, it can be said that the current value of the 4/19/2024 $43.00 call option is overpriced
- It’s all about supply & demand
Discussion
Theoretical option values can be calculated using option pricing models. These are only guidelines. Real option value is determined by what traders are willing to pay for the option, and that is based on supply and demand. Market-makers will publish the NBBO, and these are the prices we pay or receive from our option trades.
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Your generous testimonials
Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to publish several of these testimonials in our blog articles. We will never use a last name unless given permission:
Alan,
Thank you for the continued membership. The fact that you take the time to personally respond to emails is amazing. I appreciate you, the knowledge you’ve shared, the BCI methodology and your service to our country as a dentist, and as a teacher to our fellow blue-collar investors. I’m looking to acquire my first real estate property in NYC thanks to the over $100k I’ve accumulated in the last 3 years using the BCI methodology.
Thank you, Alan. I’ve recommended your products to quite a few people overseas.
Clare
MAJ. US Army
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11 AM ET – 12 PM ET
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Portfolio Overwriting: Covered Call Writing Our Buy-And-Hold Stocks
Increasing profits and avoiding tax issues
Our buy-and-hold portfolios in non-sheltered accounts are generating 8% – 10% per year. Can we potentially increase these yields by selling stock options while, at the same time, dramatically decreasing the probability of our shares being sold to avoid potential tax implications? The answer is a resounding “yes”.
Portfolio Overwriting is a strategy that can benefit millions of investors seeking to enhance portfolio returns using a low-risk covered call writing-like strategy.
Traditional covered call writing will also be discussed to demonstrate comparisons between the 2 strategy approaches.
Topics discussed
Summary
Brief review of covered call writing
Option basics
What is an option-chain?
Option selection
Calculating covered call returns: Real-Life examples
Portfolio overwriting defined
Basics of strike selection
Pros and cons of portfolio overwriting
Why early exercise is so rare
Rolling options
Role of dividends
Locating ex-dividend dates
How to avoid early exercise
Avoiding earnings reports
Practical applications: Delta, implied volatility, annualized returns
Real-life examples with calculations
BCI Trade Management Calculator
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