I rarely write about finance but a decade ago I did a stint in finance and picked up a few things. One of these was the idea of options which are an interesting and powerful way to participate in the market. There’s a ton of information online describing how they work but a simple explanation is that they give you the “option,” or the right, to buy or sell shares of the underlying stock at a particular price by a future expiration date. This particular price, referred to as the strike price, and the expiration date, are the significant drivers of the price of the option. But generally, buying options on unlikely scenarios (ie far away from the current value) in the very short term ends up being extremely cheap while buying very likely scenarios with a long horizon can get very expensive. I’m not the best equipped to get into the specifics of pricing options but it’s incredibly intricate and involves some deep math that one can get lost in and is worth exploring for the mathematically minded or curious.
That aside, I started thinking about options yesterday after discovering that Snapchat was going to announce earnings today. I don’t have any shares in Snapchat and wrote a post in February describing my Snapchat investment - summarized as it’s going to volatile since there’s so much uncertainty and I should just wait to see what happens since if it does start growing it will keep growing for years, very similar to what happened with Facebook.
But this is passive and there are some interesting things we can do with options. One of my theses around Snapchat was that this earnings call would lead to either a massive decrease or increase and it’s unlikely that Snapchat would be stuck in the middle. If they showed significant progress in Q1 they would discredit the idea that Facebook was beating them and if they failed it would indicate that they will, in fact, lose to Facebook. Options are a great way to implement this idea. The way one can play this is to buy options that are out of the money on both sides - meaning we buy a put option for significantly below the current price and a call option for significantly above the current price. If the stock stays within the range we lose our investment but if it swings too much in either direction and becomes “in the money” we end up profiting. Earlier today I took a look at the Snapchat option chain for options expiring in 2 days, on May 12. Snapchat closed at just under $23 today so if go a few dollars, I chose $4 arbitrarily, and go in either direction to find the appropriate options we get a $19 put and $27 call. While the markets were open each of these cost roughly 30 cents. Then if Snapchat ended up dropping below $19 or increased to be above $27 the options would have some value. And that value is simply the difference between the stock’s current price and the option’s strike price. If Snapchat increased to $29 then the $19 put options would be worthless while the $27 call options would be worth $2 each ($29 - $27) - especially since our options would expire in 2 days so there wouldn’t be a lot of room for movement. Of course we would still have to pay for the options themselves but in this case we would come out ahead - the two options would cost us around 30 cents each but the gross return would be $2 leading to a profit of $1.40. Of course just as easily the options could have expired worthless and we would be out the 60 cents for the two options.
Unfortunately, I submitted my trades too late in the day and the markets had unfortunately closed before my orders went through so I have to take solace in the idea alone. It was also an extremely risky trade and I wasn’t going to put too much into it - small enough to make me not feel too bad about losing the cost of the options if they ended up being worthless. And while the tone of this post is very bullish on options they are incredibly risky and I’d only recommend taking a stab if you know what you’re doing and are comfortable losing the entire investment.