Day 6.Earning 200% daily! Why are end-of-day options more likely to yield high returns?

Hello

Welcome to Tiger Academy - 「Options Academy Column」 Issue 6.

In the previous article, we discussed how options buyers should avoid holding until expiration to minimize the decay of time value.

Of course, if we want to maximize our gains with minimal investment, we can choose to buy options on the expiration day itself, known as trading end-of-day options. How profitable is this strategy? Let's take Tesla as an example. On June 30th (the expiration date), the put options for Tesla generally saw an increase of over 200%, while put options with the same conditions expiring on August 18th only saw an increase of around 40%.

The question arises: why are the returns on end-of-day options so high, and what should we be aware of when trading them?

Today, let's address this question.

1.Why do end-of-day options yield higher returns?

The expiration date is a crucial factor in options trading. There are two main reasons why trading end-of-day options can lead to higher returns:

1.Time Value: As mentioned earlier, an option's price consists of intrinsic and time values. As the expiration date approaches, the time value gradually diminishes. Therefore, on the expiration day itself, the time value tends to approach zero. This allows us to purchase options at relatively lower prices, resulting in greater leverage.

Take Tesla as an example: On June 30th, there is a call option with a strike price of $255 expiring on that day. Its time value is $3.81 (with only one day remaining until expiration). In comparison, a call option expiring on July 7th under similar conditions has a time value of $9.31. Both options have the same intrinsic value. Consequently, the former option is priced $5.50 lower, leading to a higher leverage effect.

2.Volatility: Due to arbitrage and hedging activities carried out by institutional investors in the derivatives market, there is a significant buying and selling of underlying assets for settlement on the expiration day. This often leads to increased market volatility, which in turn results in more pronounced price fluctuations for end-of-day options.

2. How to trade end-of-day options correctly

While end-of-day options can help us achieve high returns with a small investment, they also come with a significant risk. Since there is no time value on the expiration day, if the price of the underlying asset moves unfavorably, the option becomes worthless, resulting in a 100% loss.

To avoid this situation, it is advisable to avoid deep out-of-the-money options as well as deep-in-the-money options. Deep-in-the-money options have a lower likelihood of turning into worthless options, but they are expensive and have a higher investment cost, which reduces the potential for high returns.

To strike a balance between maximizing gains and reducing risk, we can consider at-the-money options or options that are slightly in-the-money or out-of-the-money.

However, regardless of the external factors we consider when selecting options, the most crucial factor that contributes to increased option volatility is the price movement of the underlying asset. Option prices are influenced by significant fluctuations in the underlying asset's price. So, when does the price of the underlying asset tend to become more volatile? Stay tuned for the next installment of Tiger Cheese!

By the way, for Tiger Friends who are interested in options trading, there is an Options tour course available for you to learn.

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See you next time!