Trading Cheap Options

Topic: More Plays on Cheap Options

Dear Options Trading FAQ:

Ok, here is a question for the Options Trading FAQ. Right now a lot of technology companies are reporting and it seems a lot are coming out with earnings well above analyst’s estimates. SUNW, MSFT, INTL to name a few.

What do you think about buying calls well out of the money on a list of say 10 technology companies that you think might do well? For example, companies that would benefit from Windows 95 such as memory manufacturers, modem manufacturers, and software companies that write utilities for Windows 95.

You would have to get a list of companies that have not reported earnings yet and find options that sell for VERY cheap. Optimally I would buy calls where the bid is 0 and ask is 1/8. If the earning are even with estimates or bad you lose all. If the earnings are good, I think the bid would at least go to 1/8 and you would get your investment back. If the earnings are very good you could easily double or triple your money. If the earnings are GREAT you could walk away with a sizable sum.

This is a gamble with little downside, a lot upside, and with 10 companies you might get lucky and hit one real winner. What do you think?

Cheap Option Fan

Dear Cheap Chap:

It's not enough for the earnings to come out great, they have to come out great with very little public expectation for it to do so. Otherwise, all the public option speculation (and there is plenty at the price range you're talking about) won't allow you to find a reasonable option at 1/8.

Yes, when there is a surprise like that, you can make a killing with the cheap options. Buy enough of these longshots and some will come through. The question is will this strategy work out in the long run? The successes have to more than pay for all the failures. A detailed study of this would be informative.
Let's suggest this as a thesis project for an investment/finance MBA candidate.

Warning note: In the vast majority of cases, options with no bid or a 1/16 bid are worth just that and never move up but, rather, go straight to zero.

How about this as a strategy? (I like fooling around with this one now and again.) Wait for a high flying tech stock to announce bad news. The more scary, the better. Hopefully, the stock will halt trading and then gap way down. At the opening price (order is entered while the stock is still halted), I'm a buyer of a now cheap call option. I play this for a quick bounce. If you buy the option for 1/8 or 1/4, it may double right away on the bounce. Have the sell order placed on the floor right away so that you get out as soon as possible. After that first bounce, all bets are off. This is a strict day trade (minute trade is more like it).

What do you think about that sort of play as opposed to the method you proposed? Let's throw it out to the rest of the option traders forum for comment.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Strategy, Options Pricing

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