TipSheet #10 - Optimized Long Option Finder...

How the returns are calculated...
The calculated returns on the Optimized Long Option Finder are based on the position cost and the estimated value of the position at the selected target date. You might notice that the different strike prices listed on the table show a different # of contracts for each trade. The # of contracts that you can purchase on each strike is based on the investment amount and the current ask price of that particular option. If we plan to invest \$5,000 we could buy 10 contracts of an option with an ask price of \$5.00, or we could purchase 100 contracts of a strike with an ask price of \$0.50. In both cases, we only invest \$5,000.

For options that would naturally expire on the target date selected, the estimated price is equal to the intrinsic value that the option would retain at expiration. The intrinsic value times the number of contracts (times 100 shares per contract) gives us the estimated value at expiration. The estimated value at expiration minus the original position cost divided by the position cost is the % Return.

Example...
% Return = (Estimated Value - Original Position Cost) / (Original Position Cost)

Using a certain stock symbol and using the defaults estimating an increase of 10% and an initial investment amount of \$5,000 we see the Optimized Return:

Detailed returns from the Long Option Finder Tool

The % Return of 101.2% was calculated as:
% Return = (Estimated Value - Original Position Cost) / (Original Position Cost)
% Return = (\$9,747.00 - \$4,845.00) / (\$4,845.00)
% Return = (\$4,902.00) / (\$4,845.00)
% Return = 101.2%

For the positions in the list that are further out in time from the selected target date, the estimated price is calculated using the Black-Scholes pricing model. This gives a theoretical price of the option based on the intrinsic value plus any remaining time value. You can check the estimated price of the longer-term options by using the Black-Scholes theoretical calculator on PowerOptions and adjusting the numbers to match your speculated stock price and target date.

The Volatility (SIV) will have an important effect on the estimated price of the option. As the volatility (SIV) increases, the risk related part of the option price will increase and the estimated bid price will become inflated. The inflated estimated price will naturally yield a higher % return on the Long Option investment. If you think that the SIV value is higher than it should be, simply adjust the value that is listed in the SIV parameter field. You can use the implied volatility numbers in the Optimizer results table to compare the value of the SIV. If the SIV is several points higher than the listed implied volatilities for either the calls or the puts, you may want to recalculate the estimated bid prices using a lower SIV. Likewise, if you notice that the calculated SIV is several points lower than the implied volatilities on the listed options you may want to increase the SIV and recalculate the returns. By setting the SIV to the implied volatility for a particular option you can test the sensitivity of return based on a change in the volatility (SIV). Take some time to adjust the volatility settings and note how the bid prices and returns are affected.

Further research...
You have been tracking a certain stock. You think it is going up and you would like to purchase a call (or, you think it is going to drop and you would like to purchase a put). You enter the symbol into the Optimizer and you view potential returns based on the default values. But now you want to research the history of the stock, when the earnings are coming out, you would like to look at the cash flow and balance sheet as well as other fundamentals to determine where the stock might go. As with any other search or analysis tool on the PowerOptions site, you can do this research with one click ease form the tool.