Nearly everyone says the same thing about out of the money options – they are to dangerous and only highly experienced option traders should participate in them.  But the reality is that any stock option strategy can be dangerous at times.  The trick with out of the money options is to understand the risks and rewards, understand WHY you are buying them, utilize effective cash management, and have a planned exit strategy – BEFORE YOU BUY.

Activision(symbol: ATVI) is one name that I like for a small out of the money directional  call option play.  Check out a morning snapshot from the option chain for May and June below.  Activision is scheduled to release earnings today, after the market closes.

activision-out-of-the-money-options

From the chain above, take notice what is going on:

  • Implied volatility in the May options is very high- about 82 near the money
  • Implied volatility in the June options is also high, but not as quite – about 57 near the money
  • Open interest in the CALL options is nearly 10:1 of that of the PUT options
  • There were over 1600 contracts of the May 10 strike calls traded today (in the money)
  • Even the out of the money May 11 and May 12 options saw volume today (693 and 202)
  • Implied volatility will almost certainly drop to the 30-40 range matching the overall market after the earnings announcement later today.

Many people like the May 10 strike calls on Activision.  But if Activision drops below 10 after earnings, those options will expire worthless.  I personally like the June 11 strike (70-80 cents) or the June 12 strike options in Activision for 35-40 cents each.   Even if Activision falls to $10 after earnings, those out of the money options could still have some value left.  These out of the money option plays are risky, but for a small bet, they could prove very rewarding if Activision spikes to $12 or higher in the days following the earnings announcement.  The trick with out of the money options – or any options for that matter – is to understand the risk reward profile before placing the bet.

Disclosure: Author is long the June 11 and 12 strike calls in Activision.  (small bet!)

Disclaimer: Trade at your own risk!


May 8th Update: Activision reported good earnings yesterday as expected, and the stock closed at $11.81 on Friday.

Here is the June option chain below, as of the close on Friday.

activision-options-after-earnings

Notice how the out of the money (they were out of the money before earnings) June 11 and June 12 strike options on Activision jumped up after earnings.  Volatility also took a dive from the 55-56 level to the 47-55 level near the money.  Here are the 1 day performance results from the June 10,11 and 12 strike call options:

  • June 10 were 1.35 before earnings and about 2.00 after (48% return)
  • June 11 were about .75 before earnigns and about 1.25 after (66% return)
  • June 12 were about .40 before earnings and about .70 after  (75% return)

Also notice that June 12 strike options (out of the money prior to earnings) went up the most, even with Activision still trading under the critical $12 strike level.  Activision closed Friday’s session at $11.81.

To sum it up, out of the money options are risky plays, but they can yield healthy returns.  The trick is to understand your risk reward ahead of making any option plays.