It is very interesting to observe that the chart price movement of near the money, or near out- of money strike price. Unlike the underlying stock in rally, which maintains it pattern above the 30 day average, the option call chart has all sharp hill peaks and valleys.
I know exactly why this happens. The option prices sky rocket in short span,2-3 days, then fall down when 40-70% when the stock is consolidating. This behavior is especially when the option call price is near out of the money strike price. Once the stock crosses the strike price, the option call price is more in tune with the Black-scholes formula price. What it means is that out of money call options are very volatile and in the money options are less volatile, the reason being there is more uncertainty and risk in out of money call option.
So, from this what do we learn about exit strategy of near out of the money call option? What we learn is that one has to get out when the option price is high. These high points of a call option are in the same range numerically, when the underlying stock is in rally. This is an interesting observation. For example, ISLN, as stock in rally moved from 20 to 27 in 2 month period. But the option moved from 0.5 to max 1.5. It moved to this high point at least 2-3 times in this 2 month period. But not more than that. I formed a high shaped peak when the stock jumped approximately 5 % during its rally, then the price of call option came down sharply to 0.5 to 0.8 range during consolidation of the stock in the rally. This is a very important observation for exit strategy. That means the call option does not move up smoothly like the underlying stock in rally above a base line like a 30 day Moving average. It makes hills and valleys in the same range.
An intelligent option call trader understanding this property of the technical analysis, will exit when the call option is at its high point. probably tomorrow at 2.00 dollars. One should not be gready because even if it does not reach 2 dollars ,even if it reaches 1.9 one has to get out. Because the stock is will be approximately 5 percent up from its last consolidation range. Hence from the observation of this specific stock the consolidation come around 15-20 percent. This stock last consolidation happened at 22.5. So tomorrow its going to 28.5. The time is close to another consolidation of this stock at the range of 27.
But the funny thing is the the call option price will fall off the cliff from 1.8-2.00 range to 1 $. So will you cash out at this peak or wait and feel sorry during the next consolidation.
I am getting out buddy tomorrow, at its peak. There are a lot of thing the graph can show, about the underlying stock and also the option call behavior.
Unfortunately, these graphs of options are not available on websites like yahoo, msn, or google. One needs to have an account with a good option trader with a good software.
Its good I made the effort to look into this behavior today.