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There’s two absolute rules of option contracts. Number one: They will fluctuate in price. The reason that we’ve put a spread like this is because we’ve given it a lot of room for the price to move around in. It will fluctuate in price.
The second absolute rule of option contracts is that they expire. What happens is, today – our option contract looks like this; our profit and loss looks like this, and we’ve lost $2.93. But over time, look what happens. This is today, the white line. This green line, now, is about a week from now. A week from now, all of a sudden, if our price remains relatively stable, we have a profit of $4.15.
Then, if we go all the way out to May 4, which is just a couple weeks away – our profit is now $14.75. The options will expire. The further out – let’s say if you buy a 90 day option, an option that expires in 90 days is going to be worth more money than an option that only has 30 days left to it. Because the closer you get to expiration, the less probability that that option will actually have any value, if the price remains relatively stable.
Of course, prices fluctuate all the time. So that option contract is actually going to be worth more money at one point, and less money, at some point. Then, as we get very close to expiration, like 30 days prior to the expiration – all of a sudden, at that point, the option contract loses value on a daily basis.
Let me just show you what it looks like, on a real trade that we did. This is our green line, which is on a portfolio weighted basis, our entire position. This white line – when we first put on the trade, it was way down here. You can see that we have the strike prices of the stock down here. In this case, it’s in the EEM, which is the emerging market ETF. This is our profit and loss.
We had a maximum profit of close to about $1,000 on this trade. We are just a few days from expiration. Our live price was $139.47. This white line is our current profit position.
When we got started, it was down here. But each day that we continued to hold this trade, it kept going higher, and higher, and higher. Now, at this point, we are about one week from expiration. If you take a look at the current live price down here, where I’ve highlighted it – the important thing to think about is Theta.
We’re going to go through each one of the Greeks in the next CD, because they’re extremely important. This is where you make your money. The Theta was 45 cents. All that really means is that for each day that passes, the option contract is declining by $45.28 cents, each and every day.
If we take a look at our current profit and loss open, we have a $500 profit so far, on this trade, in just two weeks. On this one trade. We are generating $148.33 in profit, per day. Every single day. As long as we continue to hold this trade, this white line will continue to go up, and up, until we meet our maximum profit.
Generally, though, we do not like to hold our contracts all the way to the expiration. We usually try to close them out around the 50%-70% mark, and sometimes down at the 30% mark, depending on what kind of price risk we have.
This is holding relatively stable. We had to adjust this trade. In other words, our current price is $139.47, which is right in the center of what we call our profit graph. Our profit picture. We love profit pictures. Profit pictures are extremely important, not only for determining when adjustments are necessary, but it’s also extremely important to see where exactly our profit and loss figures are, because if the price gets up to our breakeven point, we need to do an adjustment.
We had to do an adjustment on this trade, because the price had gotten very far up on the line here. We needed to adjust our trade, so it came back toward the center. Being in the center of this profit graph will ensure that you are always in a profitable position in a trade.
It doesn’t mean that you’re always going to have a profitable trade. It only means that if you do adjustments at the right time – and the time of your adjustment is very important -than you will never get hurt really bad, in the market. You put yourself into a position where you can be profitable.
This is typically what the winding down of a very good trade will look like. You will be making money every single day. You will have a very positive profit position. As you can see from this, the current price is $139.47. We’re making $148 a day. Even if the price were to move against us by two points, we’re still making $100 a day.
If it goes down by two points, we’re making $130 a day. Either way, this was a very profitable position that we closed out. That’s what a profitable position will look like.
That’s exactly what this graph will show you. Over time, your position will become more and more profitable. That option, when it gets closer to expiration, will lose value. You’ve sold that option to someone else, who thinks that the market was going to in a certain direction. It didn’t, and you were able to collect that time premium for that contract.