How the traders take profit from options that has too far Out Of The Money strike price?

Question

Looking at the Amazon Options on this Yahoo page, there are 121 options interest for June 17, 2022 for the strike price of $5000. Assume that some traders bought the options when the stock price was at $2500 on June 15, 2020.
My questions are:

Why the traders buy options that far into the future and with a high out of the money strike price?
Can these traders make any profit for the investment that they have made between from now and June 17, 2022, not waiting until the expiration?
The stock price of Amazon is $3000 today. Can the traders make any profit because the price has moved from $2500 to $3000, but not above $5000?

Acccumulation · Accepted Answer

The value of an out-of-money option comes from the possibility that the stock fluctuations will be large enough, and in the right direction, to put it in the money. The longer the time frame, the more opportunity there is for the option to go into the money, and so it will be more valuable. As time goes on, there's less opportunity to get into the money. Thus, if the stock price remains constant, the value of the option will decrease over time. This is known as "theta". For an option to retain its value, the stock movement has to keep pace with theta. If it lags behind, the value decreases. If it outpaces it, the value increases.

The catch-all answer is "because they think they're underpriced".

If there's an active market for the options and they're outpacing theta, then the original owners can cash out by selling them to other traders. If they can't find buyers, however, they'll have to wait, even if the theoretical value of the option has increased.

A definitive answer as to whether the options have increased in value would require more data than you've provided. It would depend on factors such as the original price and the implied volatility, and whether there are expected non-Gaussian distributions. If you're asking whether an option in general can increase in value in such circumstances, the answer is yes.

Cobuz Alexandru · Answer

There are some strategies that can take advantage while being far out from the strike price, even at something that may look that's never going to happen. That is intended.
You can sell an option call of Amazon at 5000 and they may buy a call at 5005, which will limit their potential loss. The user will collect a premium for that risk.
In this case, the intention of the buy call at 5005 is to limit the risk.
As long as the stock will < 5000 up to a certain date, they will collect a premium by risking only $500 which is the difference between the 5005 and the 5000 contracts  ((5005-5000) x 100).
Now to answer your questions:

Higher timeframe, because it's a higher theta you will collect higher premiums
Yes, because the option prices actually depend on the stock price and the time decays exponentially
Yes, check the example from above.

Bob Baerker · Answer

It's hard to make a good case for buying or selling a June 2022 $5,000 call.  However, not all investors and traders are logical.
Here are some possible reasons for using far OTM options:

The option is under or overvalued and the outlook is for a reversal in IV and price

The option is being used for risk control in a more complex option strategy (vertical spread instead of naked option)

The option is being used to reduce the margin requirement, more so if one is using portfolio margin.

Market makers and traders execute arbitrage strategies like conversions and reversals to not only lock in risk free gains but to lay off risk. For a simplified example, suppose XYZ is $1,000 and there's a buyer for Aug $800 calls. If the price is attractive enough to the MM, he can sell the call to the buyer and lay off the risk by simultaneously buying the stock and buying the Aug $800 put (an arb strategy called a conversion). The put purchase is part of a larger strategy.

How the traders take profit from options that has too far Out Of The Money strike price?

3 Answers

Add your own answers!

Ask a Question